Gift of Home Equity: What It Is and How it Works

By Dan Armstrong, Attorney, Jacksonville Beach, FL

We are living through what’s been called the largest intergenerational wealth transfer in history. Tens of trillions of dollars are set to change hands between older and younger Americans over the next 20 years.

More and more elders are choosing to pass on their wealth to heirs while they’re still alive. The growing popularity of “giving while living” comes as good fortune for the many young people who are currently unable to afford a home. And for older homeowners, gifting home equity and other assets before death can be part of their estate planning strategy.

Transferring property using a gift of equity has financial implications for both the buyer and seller that may need to be discussed with an attorney.

The Great Wealth Transfer and the Home Affordability Crisis

Total U.S. family wealth more than tripled from 1989 to 2022, from $38 trillion to $140 trillion. Baby Boomers, born between 1946 and 1964, hold an estimated $78.3 trillion in assets — half of the nation’s wealth. The Silent Generation, born before 1946, owns approximately $18 trillion in assets.

As members of these generations die, they will transfer a historically large amount of wealth — a projected $84.4 trillion by 2045 — according to market intelligence firm Cerulli Associates . Most of this will pass down to heirs, primarily members of Generation X, Millennials, and Gen Z.

For young adults, this “Greatest Wealth Transfer in History” couldn’t come at a better time. Almost half of 18- to 29-year-olds are currently residing with their parents , the highest level since the Great Depression.

One of the key factors influencing young adults living at home is high rents and home prices. Millennials and Gen Z have been priced out of purchasing homes, and often even the rental market, because of dwindling housing affordability .

Gifting While Living and the Gift of Equity

Running through the boom-and-bust fortunes of Americans at opposite ends of the age spectrum is a third trend that could provide a much-needed compromise: gifting while living.

Heirs are increasingly not having to wait for their parents to pass away to collect their inheritance. Nearly two-thirds of Americans now favor gifting part of their estate during their lifetime, compared to just 27 percent who say they will give it all away after they pass, research from Merrill Lynch shows.

Giving while living, which includes transfers of cash and real estate, is giving millions of heirs a head start on their inheritances. Merrill Lynch says that the Great Wealth Transfer should help more young Americans become homeowners through either inherited property or funds for a down payment.

Rather than gifting a home or a down payment outright to their children, grandchildren, or another family member, older homeowners may choose to give a gift of equity — the sale of a home to a buyer for a price below market value.

A gift of equity, which represents a portion of the seller’s equity in the property, is transferred to the buyer as a credit in the home purchase transaction and works similarly to a down payment gift. In fact, a gift of equity can be used to fund all or part of the down payment, as well as closing costs, on the purchase.

How a Gift of Equity Works

Home equity is how much a property is worth, minus the amount of a mortgage and other debts that is owed on it.

When a homeowner gives a gift of home equity to a family member, they are gifting them a part of their home’s value. The home is sold for below market value, and the buyer receives more equity in the home than they would have had if paying fair market value for it.

A gift of equity is equal to the difference between the appraised value of the home and its sale price. For example, if a couple owns a home worth $400,000 and they sell it to their daughter for $200,000, the daughter has received a $200,000 gift of equity.

Buyer and Seller Requirements

Giving a gift of equity is not as simple as just agreeing to a below-market deal for the home price. To complete a transaction involving an equity gift, both parties must meet certain requirements:

• The seller must obtain an official home appraisal to ascertain fair market value and also sign a gift letter that describes the buyer-seller relationship and states that the equity is a gift the buyer is not obligated to repay.
• The buyer must follow the typical process for buying a home. That means applying for a mortgage (assuming the amount of the gift is less than the home’s full value) and submitting the necessary documentation, such as tax returns, proof of income, and bank account statements, to the lender. Closing costs should decrease given the lower purchase price, but the buyer is still responsible for paying them.

These requirements may vary slightly by lender. Check with a financial institution to see what specific documentation they need to complete a gift of equity transaction.

Home Equity Gift and Estate Planning

For the recipient, a gift of home equity can be quite valuable. A home is typically the single largest asset a person will ever own, and its equity increases their wealth over time. Home equity can also be tapped to receive a loan and lines of credit.

An equity gift can benefit the giver, too. Not only can it accelerate the home buying process and ensure that the family home stays within the family, but giving home equity can be part of an estate planning strategy to distribute assets prior to death.

Moving a home and other assets out of the estate can reduce the amount of the taxable estate, helping to avoid the federal estate tax and any estate or inheritance taxes imposed at the state level. With the current historically high lifetime gift tax exemption amounts set to expire at the end of 2025 and revert to much lower levels, now might be a great time to use a home equity gift as an estate planning tool.

Another benefit of transferring the home during the owner’s lifetime is that it doesn’t have to go through probate — the court process of proving a will is valid — when they die. The more complex probate is, the longer and more expensive it can be.

Elder homeowners who want to transfer a home to their children while continuing to live in it might also consider estate planning strategies like a Qualified Personal Residence Trust and a life estate.

Downsides to a Gift of Equity

The financial loss of selling their home at below market value is unlikely to be the seller’s top priority. Yet they should additionally be aware that a gift of equity could trigger the gift tax if it exceeds the annual gift tax exclusion amount. (As of 2024, you are allowed to gift up to $18,000 per individual, or $36,000 per married couple.)

And if the gifted equity is used to purchase an investment home, rather than a primary residence or second home, the lender may limit the allowable gift amount and impose other restrictions .

A better strategy for leaving an investment property to a loved one might be to utilize a 1031 exchange. This way, you can minimize the next generation’s capital gains tax liability.

Capital gains taxes, unfortunately, may be higher after a gift of equity, which can affect the property’s cost basis and cause the capital gains to be higher when the recipient sells the home.

It’s Better to Give – But Give Wisely

If you’re considering giving the gift of equity to a loved one, connect with your?estate planning attorney. You can discuss with them such a transaction would fit into your financial and estate planning goals. Estate planners can provide guidance on tax implications, structure gifts to minimize capital gains, and execute other estate planning documents.

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Questions? Contact us at The Law Offices of Dan W. Armstrong, P.A.

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The Law Offices of Dan W. Armstrong, P.A.

1400 Marsh Landing Parkway | Suite 108 | Jacksonville Beach , FL 32250

https://www.DanArmstrong.com