A gift of equity works like this: a homeowner sells their property to a relative for less than its appraised value, and the lender treats the price difference as the buyer’s down payment. No money moves between the two parties for that portion. If a house appraises at $400,000 and the family sale price is $320,000, the $80,000 gap is the gift, and the buyer finances the $320,000 without needing separate down payment savings.
The equity already sits inside the home. The seller is simply agreeing to accept less than market value, and the lender documents the gap as if it were a traditional cash down payment. That single move is what makes these transactions useful: a buyer who could not save 20 percent can still walk in with 20 percent of built-in equity on day one.
How the Gift Amount Is Calculated
Every gift of equity starts with a professional appraisal by a licensed, independent appraiser. The gift equals the appraised value minus the agreed sale price. Using the example above, $400,000 minus $320,000 leaves an $80,000 gift, which happens to equal a 20 percent down payment.
Hitting that 20 percent threshold matters. A gift large enough to cover 20 percent of appraised value generally lets the buyer skip private mortgage insurance, which lenders require on conventional loans with smaller down payments. Under Fannie Mae guidelines, the gift can fund the down payment and closing costs, including prepaid items like homeowners insurance and property taxes collected at settlement. It cannot count toward the buyer’s post-closing financial reserves.1Fannie Mae. B3-4.3-05, Gifts of Equity
Who Can Give a Gift of Equity
Because the buyer and seller already know each other, lenders classify these as non-arm’s-length transactions and limit who can participate. The rules depend on the loan type.
For FHA loans, only family members qualify as donors. HUD defines family broadly: parents, grandparents, children (including step and foster children), siblings, stepbrothers, stepsisters, aunts, uncles, in-laws, domestic partners, and legally adopted children. Close friends do not qualify.2U.S. Department of Housing and Urban Development. Does HUD Allow Gifts of Equity?
Conventional loans backed by Fannie Mae accept the same family relationships and add domestic partners, fiancés, former relatives, and individuals with a long-standing familial or mentorship relationship with the borrower.3Fannie Mae. Personal Gifts VA loans have their own gift-fund rules in Chapter 4 of the VA Lenders Handbook, and veterans should confirm the details with a VA-approved lender.
One boundary worth naming: the home has to be a primary residence or a second home. Fannie Mae does not allow gifts of equity on investment property purchases.1Fannie Mae. B3-4.3-05, Gifts of Equity
Paperwork the Lender Will Ask For
Every gift of equity needs a formal gift letter before the loan can close. For FHA files, HUD requires the letter to include the donor’s name, address, and phone number; the donor’s relationship to the borrower; the dollar amount; and a statement that no repayment is expected.2U.S. Department of Housing and Urban Development. Does HUD Allow Gifts of Equity? Conventional lenders use similar language, and most provide their own template so nothing is missed.
The purchase agreement itself must reference the gift of equity in the financial terms. That lets the title company and the underwriter reconcile the below-market price with the loan amount. The lender will also want the full appraisal report so it can verify the gift matches its loan-to-value math, and the seller should have proof of ownership ready for the title company.
What Happens at Closing
At closing, the gift appears as a credit to the buyer on the Closing Disclosure, the settlement document that itemizes every dollar in the transaction.1Fannie Mae. B3-4.3-05, Gifts of Equity The title or escrow officer records it as a line item that satisfies the down payment and, if the gift is large enough, some or all of the closing costs. Nothing is wired between seller and buyer for the gifted portion because the equity is already inside the home. Once documents are signed, title transfers and the buyer takes ownership.
Gift Tax and IRS Form 709
The IRS treats a gift of equity like any other gift, and the seller is the one who reports it. If the gift exceeds the annual gift tax exclusion, which is $19,000 per recipient for 2026, the seller must file IRS Form 709.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Filing does not mean tax is owed. The form tracks how much of the seller’s lifetime exemption has been used.
The lifetime gift and estate tax exemption for 2026 is $15,000,000 per individual.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 A gift of equity above the annual exclusion reduces that lifetime figure but produces no actual tax unless the seller has already given away more than $15 million during their life. Very few families will ever pay gift tax on one of these transactions, but the Form 709 filing requirement still applies whenever the annual threshold is crossed.
Married sellers can elect to split the gift on their tax returns, which effectively doubles the annual exclusion to $38,000.5Internal Revenue Service. Instructions for Form 709 Both spouses must file Form 709 and consent to gift splitting, even when only one spouse held title.
Capital Gains for the Seller
The seller may also owe capital gains on the sale portion. Taxable gain equals the sale price received minus the seller’s adjusted basis. The gifted portion is not counted as amount realized, so only the actual proceeds figure into the calculation.
A seller who lived in the home as a primary residence for at least two of the five years before the sale can use the Section 121 exclusion to shelter up to $250,000 in gain, or $500,000 for married couples filing jointly.6Internal Revenue Service. Selling Your Home In most family transactions that exclusion wipes out any tax owed. Sellers who rented the property or used it for business may face limits tied to depreciation taken during those periods.
The Buyer’s Future Tax Basis
Because the deal is treated as part gift and part sale, the buyer’s basis is the greater of the amount actually paid or the seller’s adjusted basis at the time of transfer.7eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale Most of the time the mortgage price is higher than what the seller originally paid, so the buyer’s basis equals the purchase price. If the seller bought for $150,000 years ago and the buyer purchases for $320,000, the buyer’s basis is $320,000. Keep records of the price, the appraisal, and any post-purchase improvements so gain can be computed accurately when the buyer eventually sells.
Two Traps to Check Before You Sign
A gift of equity can only come from equity the seller actually owns. The sale price has to cover any remaining mortgage balance. A seller who owes $350,000 on a $400,000 home has $50,000 of equity to work with, not $80,000, and would need to bring cash to closing to make a larger gift work.
Transferring property can also trigger a due-on-sale clause, which lets the existing lender demand the full loan balance immediately. Federal law blocks lenders from enforcing that clause when a spouse or child of the borrower becomes an owner.8Office of the Law Revision Counsel. 12 U.S. Code 1701j-3 – Preemption of Due-on-Sale Prohibitions Transfers to siblings, nieces, or nephews get no automatic protection. In practice the buyer’s new mortgage pays off the seller’s old loan at closing, which resolves the issue, but the seller should confirm the sale proceeds will clear the existing balance before agreeing to a below-market price.
The second trap matters for older sellers. Federal law requires states to review asset transfers made within 60 months before a Medicaid long-term care application.9Office of the Law Revision Counsel. 42 U.S. Code 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets Any transfer for less than fair market value inside that window, including a gift of equity, can trigger a penalty period during which the applicant is ineligible for Medicaid-funded nursing home care. The penalty length is the gift value divided by the state’s average monthly private nursing home cost, and a large gift can produce many months of ineligibility. Anyone who might need long-term care within five years should speak with an elder law attorney before selling below market value.