How Much Can Parents Gift for a Down Payment?

Parents often help their children with home down payments. This financial assistance, while a generous act, involves specific federal tax regulations and mortgage lender requirements. Understanding these rules is important for both the parents providing the gift and the children receiving it, ensuring compliance and a smooth home-buying process. This article explores the federal gift tax implications for such transfers and the necessary documentation for mortgage approval.

Understanding Federal Gift Tax Rules

A “gift” for federal tax purposes refers to any transfer of money or property to another individual where nothing of equal value is received in return. When parents provide funds for a down payment, it must be a clear gift, not a loan, to comply with tax and lending regulations. The individual making the gift, known as the donor, is typically responsible for any potential gift tax, not the recipient. Under federal tax law, gifts are generally not considered taxable income for the person receiving them.

For the year 2022, an individual can gift up to $16,000 to any one person without reporting the gift to the Internal Revenue Service (IRS) or using their lifetime exemption. This amount is known as the annual gift tax exclusion. There is no limit to the number of individuals one can gift this amount to in a single year.

Married couples have an advantage with gift splitting. Each parent can use their individual annual exclusion for the same recipient, effectively doubling the tax-free annual gift amount. This means that in 2022, a married couple could jointly gift $32,000 to one child without triggering any gift tax reporting requirements.

Any gift exceeding the annual exclusion amount reduces the donor’s lifetime gift tax exclusion. For 2022, the lifetime gift tax exclusion amount was $12,060,000 per individual. While gifts over the annual exclusion must be reported to the IRS, they generally do not incur immediate gift tax unless the donor’s cumulative lifetime gifts exceed this lifetime limit. This exclusion is unified with the estate tax exclusion, meaning it covers transfers made during life and at death.

Donor Reporting Obligations

If a gift to an individual exceeds the annual exclusion amount, the donor is required to file IRS Form 709, titled “United States Gift (and Generation-Skipping Transfer) Tax Return.” This form serves to inform the IRS of the gift and track the amount that reduces the donor’s lifetime gift tax exclusion. Even if no gift tax is immediately owed, filing Form 709 is mandatory for reportable gifts.

The donor is solely responsible for preparing and submitting Form 709. This form is used to report gifts made during the calendar year, and a separate return must be filed for each year a reportable gift is given.

To properly complete Form 709, specific information about the gift and the parties involved must be provided, including:
The donor’s identifying information, such as their name, address, and taxpayer identification number.
The donee’s identifying information, including their name and relationship to the donor.
A clear description of the gift, such as “cash for down payment on real estate.”
The exact date the gift was made and its fair market value.

The filing deadline for Form 709 is generally April 15th of the year following the calendar year in which the gift was made. An extension for filing an income tax return can also extend the deadline for Form 709.

Mortgage Lender Requirements for Gifted Funds

Mortgage lenders require specific documentation for gifted funds used in a down payment to ensure the money is legitimately sourced and not a hidden loan. This verification process helps lenders assess the borrower’s true financial standing and mitigate risks such as potential fraud or money laundering. Lenders need to confirm that the funds are a true gift, with no expectation of repayment, as a loan would increase the borrower’s debt obligations.

A gift letter is a mandatory document that must be provided to the mortgage lender when using gifted funds for a down payment. This letter serves as formal proof that the money is a gift and not a loan. The lender typically provides a template for this letter, though a self-prepared letter with all required information is also acceptable.

The gift letter must include:
The full name, address, and contact information of the donor.
Their relationship to the donee.
The exact amount of the gift and confirmation that the money is a gift with no repayment expected.
The address of the property being purchased.
The letter must be signed and dated by the donor.

In addition to the gift letter, lenders will require proof of funds from the donor. This typically involves providing recent bank statements from the donor’s account, demonstrating that the funds were available prior to the transfer to the recipient. Documentation of the actual transfer itself, such as a wire transfer confirmation or a copy of the check, may also be required.

Lenders also consider the concept of “seasoning” of funds, referring to how long money has been in a bank account. While some lenders prefer that funds be “seasoned” (typically in the recipient’s account for at least 60 days), gifted funds often have exceptions to this rule if they are properly documented with a gift letter and proof of transfer. This means that gifted funds can often be used immediately, provided all necessary documentation is submitted to the lender.