What Is a Gift of Equity and How Does It Work?

A gift of equity is a transaction where a property owner sells a home to a buyer, often a family member, for less than its fair market value. The difference between the market value and the sales price constitutes the gift, which is used by the buyer to cover the down payment for their mortgage. For instance, if a home appraised at $400,000 is sold to a relative for $320,000, the $80,000 difference is the gift of equity.

This arrangement helps the buyer secure financing by satisfying lender requirements that the down payment is from a legitimate source, making homeownership more attainable.

Gift Tax Considerations for the Seller

When a seller provides a gift of equity, the value of the gift is subject to federal tax regulations. The gift’s value is the difference between the home’s fair market value (FMV) and the lower sale price. This amount is what the Internal Revenue Service (IRS) considers for gift tax purposes.

The IRS has an annual gift tax exclusion, which allows individuals to give up to a certain amount each year without filing a gift tax return. For 2025, this amount is $19,000 per recipient. A married couple can combine their exclusions to gift up to $38,000 to one person without tax consequences.

If the gifted equity exceeds the annual exclusion, the seller must file IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Filing this form does not automatically mean taxes are due. The excess amount is applied against the seller’s lifetime gift tax exemption, which is $13.99 million for 2025. Only after this lifetime exemption is exhausted would the seller owe any gift tax.

For example, a parent sells a home with an FMV of $500,000 to their child for $400,000, resulting in a $100,000 gift of equity. The parent would apply their $19,000 annual exclusion, leaving a taxable gift of $81,000. They must report this amount on Form 709, which reduces their lifetime exemption, but no tax is paid unless the exemption was previously used up.

Financial Impact on the Buyer

For the buyer, receiving a gift of equity has a primary financial benefit: the gift is not considered taxable income. The recipient does not need to report the value of the equity gift as income on their tax return. This allows them to receive a benefit for their down payment without an immediate tax burden.

A long-term consequence for the buyer relates to the property’s cost basis, which is the original value of an asset for tax purposes. In a gift of equity transaction, the buyer’s cost basis is the price they paid for the home, not its higher fair market value at the time of purchase.

This lower cost basis affects future capital gains taxes. If a buyer acquires a home valued at $500,000 for $400,000, their cost basis is $400,000. If they later sell the property for $600,000, their taxable capital gain would be $200,000, before considering any capital improvements or selling costs.

Documentation for the Lender

To secure a mortgage, the lender requires a formal gift letter signed by the seller. This document provides official verification that the equity is a true gift and not a loan that requires repayment.

The gift letter must contain specific information for the loan underwriters, including:

• The donor’s full name, address, and phone number, as well as the buyer’s name.
• The full address of the property being sold.
• The exact dollar amount of the equity being gifted.
• A statement confirming the funds are a gift with no expectation of repayment.
• The relationship between the donor and the recipient.

Executing the Gift of Equity in a Sale

Once the buyer’s loan is approved, the gifted equity is recorded on the Closing Disclosure (CD). The gift is listed as a credit to the buyer, which reduces the amount of cash they need to bring to closing.

A property appraisal is required by the lender. This independent appraisal verifies that the home’s fair market value is sufficient to cover both the sale price and the gifted equity. This confirmation assures the lender that the loan-to-value ratio is within acceptable limits and the property is adequate collateral. The appraisal protects both the lender and the buyer.

At the closing meeting, all parties sign the final legal documents. The seller signs the deed, transferring ownership to the buyer, and the buyer signs the mortgage and promissory note. The settlement agent or attorney ensures the gift of equity is correctly applied on the final statements. This finalizes the legal transfer of the property and the execution of the equity gift.