Essay

Gift of Equity: How It Works, Rules, Limits and Letter

A gift of equity lets a family member sell you a home below market value. Learn the lender rules, letter contents, tax basics and steps to use it.

David Mordue
November 13, 202613 min read
Last reviewed for accuracy November 13, 2026NMLS #120640Licensed in WA, OR Equal Housing Lender
Gift of Equity: How It Works, Rules, Limits and Letter
Gift of Equity: How It Works, Rules, Limits and Letter

Parent hands home keys to adult daughter

A gift of equity happens when a homeowner sells a home to a family member for less than its appraised value and treats the difference as a gift. The gifted portion counts as equity the buyer already owns at closing, so it can cover some or all of the down payment without any cash changing hands. Lenders allow it, but they require an appraisal, a signed gift letter and correct closing paperwork. The donor also has tax reporting to consider.

This guide explains how the math works, who can give a gift of equity, what the major mortgage programs allow, what the letter must say and how the taxes work. It also covers the steps to take so your closing goes smoothly.

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TL;DR

  • A gift of equity is the gap between a home’s appraised value and the lower price a relative agrees to accept. That gap acts as your down payment equity.
  • Fannie Mae and Freddie Mac allow it on a primary residence or second home. Freddie Mac does not allow gifts on investment property mortgages.
  • Your lender will ask for an appraisal, a signed gift letter and a Closing Disclosure that shows the gift.
  • The donor, not the buyer, handles any federal gift-tax reporting. The buyer’s tax basis in the home is usually the seller’s, which can matter when you sell later.
  • Talk to your loan officer before you sign a purchase contract, because the loan program changes the limits.

Table of Contents

What a gift of equity is and how the math works

In a gift of equity, the seller agrees to a sale price below the home’s appraised value. Investopedia describes it as selling to a family member below market value, which effectively gifts part of the property’s equity. The formula is simple: appraised value minus agreed sale price equals the gift amount.

Here is an example with round numbers. Your parents own a home appraised at $400,000. They agree to sell it to you for $360,000. The $40,000 difference is the gift of equity. With a $360,000 price and a $40,000 credit toward equity, you have 11.1% equity from day one on the price you pay, measured against the appraised value. You still need a mortgage for the rest, and your lender sets the loan amount from the lower of the price and the appraisal.

Gift of equity calculation from appraisal and sale price

No cash changes hands for the gifted portion. According to Fortune’s explanation, the lender treats the difference as equity the buyer owns from the moment the deal closes. The process typically involves an independent appraisal, a signed gift of equity letter and lender review before the loan is approved.

Why families use it

  • A smaller cash need at closing. The gifted equity can stand in for a down payment.
  • A lower purchase price. Investopedia notes that a lower price can reduce closing costs and that the home stays in the family.
  • Possible mortgage insurance savings. A larger equity position can help you avoid or reduce private mortgage insurance, depending on your loan type and the loan-to-value ratio.
  • Estate planning. A gift of equity lets a homeowner transfer property during their lifetime, which may reduce future estate taxes.

Who can give a gift of equity

Lenders do not accept a gift of equity from just anyone. Fannie Mae’s personal gifts rules say an acceptable donor is a relative: the borrower’s spouse, child or other dependent, or a person related by blood, marriage, adoption or legal guardianship. A non-relative can also qualify if there is a familial relationship, such as a domestic partner, a fiancé(e), a former relative or someone with a long-standing, family-like or mentorship relationship.

The donor may not be affiliated with the builder, developer, real estate agent or any other interested party in the sale.

Freddie Mac uses the term “Related Person.” Its Seller/Servicer Guide says a gift or gift of equity is an eligible source of funds when the funds do not have to be repaid and the donor is a Related Person, the estate of a Related Person, or a trust established by a Related Person.

Gift of equity rules and limits by loan type

There is no single national dollar cap on the gift itself. The limits come from your loan program, the occupancy of the home and the loan-to-value (LTV) ratio. The table summarizes what the guidelines in our research say.

Loan program What the guidelines say
Fannie Mae conventional Gift of equity allowed on principal residence and second home purchases. It can fund all or part of the down payment and closing costs, including prepaid items, but not financial reserves.
Freddie Mac conventional Gifts and gifts of equity are eligible for primary residences and second homes. Gifts are not eligible for investment property mortgages.
FHA Family sales are treated as “identity of interest” transactions, which typically cap the loan at 85% of appraised value, with exceptions.

Sources for the table: Fannie Mae on gifts of equity, Freddie Mac Section 5501.4 and LegalClarity on FHA family transactions.

How much of your own money you still need

The minimum contribution from your own funds depends on the LTV and the property type. Under Fannie Mae’s rules:

  • With an LTV of 80% or less on a one- to four-unit principal residence or second home, no minimum contribution from your own funds is required. All the funds needed can come from a gift.
  • With an LTV above 80% on a one-unit principal residence, no minimum is required either.
  • With an LTV above 80% on a two- to four-unit principal residence or a second home, you must make a 5% minimum contribution from your own funds.

Freddie Mac has a similar condition for second homes. When the mortgage is secured by a second home and the LTV, TLTV or HTLTV ratio is above 80%, the gift is permitted only if you put down at least 5% from your own personal funds.

FHA loans and the 85% question

Because a sale between relatives is an identity-of-interest transaction, FHA usually limits the loan to 85% of the appraised value. LegalClarity reports that a higher LTV may be available if the property is the seller’s primary residence, or if the buyer has rented the home for at least six months before signing the purchase contract. Because these exceptions depend on your exact situation, have your loan officer confirm which one applies before you set the sale price. You can read about our FHA loan options to see how these loans work.

What a gift of equity letter must say

The gift letter is the document that tells the lender the gift is real and that nothing is owed back. Lenders may have their own template, so ask for it early. The core contents are consistent across programs.

For conventional loans, Freddie Mac’s guide says the letter must:

  1. Confirm that the gift does not have to be repaid.
  2. State the actual or maximum gift amount.
  3. Include the donor’s mailing address and telephone number.
  4. Identify the donor and the donor’s relationship to the borrower.
  5. Be signed by the donor. For a trust or estate, the trustee or authorized representative signs.

The gift of equity must also appear on the Settlement or Closing Disclosure.

For FHA loans, LegalClarity states that both the buyer and donor sign and date the letter. It lists the donor’s full name, address, phone number, relationship to the borrower, the exact dollar amount of the gift and a statement that no repayment is required.

Two practical points. First, the dollar amount in the letter should match the difference between the appraised value and the contract price. If the appraisal changes, the letter may need to be updated. Second, never leave a side agreement to repay the gift. A gift that is repaid, even informally, is a loan, and the lender can refuse the file.

How to buy a home with a gift of equity: step by step

  1. Talk to a mortgage professional first. Confirm the loan program, the occupancy type and the maximum LTV before the family agrees on a price.
  2. Order an appraisal. The appraised value sets the size of the gift. The seller and buyer should not guess at value.
  3. Agree on the price and the gift amount. The purchase contract states the sale price. The gift is the difference from the appraised value.
  4. Check the seller’s payoff. If the seller still has a mortgage, it is paid from the sale proceeds first. Fortune notes that when the balance is close to the agreed price, the seller should make sure the proceeds are enough to clear it.
  5. Sign the gift letter. Complete the lender’s template, with all required details and signatures.
  6. Finish underwriting. Provide your income, asset and credit documents as usual.
  7. Close. The title or settlement agent shows the gift of equity on the Closing Disclosure.

If you want to see what price range fits your budget before you talk to family, try our conventional affordability calculator or the FHA affordability calculator.

Taxes on a gift of equity

Tax questions are the most common worry on both sides of the transaction. These are general US federal points; talk to a CPA or tax attorney about your own return.

The donor reports, the buyer does not

The donor is responsible for gift-tax reporting. According to Effective Agents, the 2026 annual exclusion is $19,000 per recipient, and a married couple can give up to $38,000 per recipient by electing to split gifts. If the gift is larger, the donor files Form 709, and the excess reduces the lifetime exemption. The buyer does not report the gift as income or owe gift tax.

The 2026 lifetime basic exclusion amount is $15,000,000, under legislation signed July 4, 2025. For most families, that means filing a form but owing no gift tax. Filing is still required, so the donor should not skip it.

Worked example: your parents gift $40,000 of equity. Two parents splitting the gift can use up to $38,000 of annual exclusion for you, so about $2,000 would exceed it, and they would file Form 709 and reduce the lifetime amount by that excess.

The donor reports, the buyer does not

A bargain sale for the seller

The IRS treats a below-market sale that is intended as a gift as a bargain sale, splitting it into a sale part and a gift part. If the sale price exceeds the seller’s adjusted basis, the seller has a taxable gain. If the seller’s basis is higher than the price, the loss is not deductible, because losses on bargain sales intended as gifts are disallowed.

The seller may be able to use the home-sale exclusion. The Section 121 exclusion allows up to $250,000 of gain for single filers and $500,000 for married couples filing jointly, and it applies to a sale to a family member as on any other principal residence sale, if the ownership-and-use tests are met.

The buyer’s basis

This is the point buyers overlook. In a part-sale, part-gift, your tax basis is generally the greater of the amount you paid or the donor’s adjusted basis, not the appraised value at closing. That can mean a larger capital gain when you sell later. LegalClarity calls getting the basis right the most important long-term tax consideration in these deals. Keep the seller’s purchase records and any improvement receipts, and ask your tax professional how to document your basis.

Gift of equity versus other ways to help a buyer

A gift of equity is not the same as a cash gift. With a cash gift, a relative gives you money from their account, and the lender asks for documentation of the donor’s funds and the transfer. With a gift of equity, there is no transfer of money for the gifted part, because it is built into a lower price. It also differs from a seller concession, which is a credit toward the buyer’s closing costs in an arm’s-length sale.

A gift of equity only works when the family member is the seller. If your relative isn’t selling you their own home, a documented cash gift may be the route to ask your lender about.

Estate planning and the family home

For some families the gift of equity is part of a larger plan to pass on property while the owner is alive, which can also reduce future estate taxes, as Investopedia notes. Other tools, such as wills, trusts and deeds, serve different goals. An attorney can explain which fits your state and family, and estate planning lawyers can help sellers weigh a gift of equity against other transfer options.

Our perspective

We see gifts of equity most often when parents or grandparents want to help a child buy a first home and the buyer has steady income but limited savings. The idea is sound, and lenders do approve these transactions. What makes the difference is the order of operations.

Start with the loan program. The limits on LTV, occupancy and the buyer’s own contribution come from the program, and the price should be set to fit them, not the other way around. Then get the appraisal and the gift letter right, because small errors in the amount or the signatures slow the file down.

Our approach is to compare options across lenders, walk you through the numbers in a personal consultation and keep the application fully online, so the family is not chasing paperwork. Our process can lead to funding in under 21 days. That speed helps when a family sale has a set closing date.

David Mordue

Ready to plan your purchase?

If a relative is willing to sell you a home at a gift-of-equity price, the first step is to find out which loan fits and what your numbers look like. We offer home purchase loans through a fully online application, personalized consultations and expert rate comparison across lenders.

David Mordue - Forward Financial Group

See what you qualify for: start your home purchase pre-approval or review the Home Purchase options on our site. If you are comparing buying with renting first, our rent vs buy calculator can help.

FAQ

Is there a limit on a gift of equity?

There is no single dollar cap in the guidelines we reviewed. The practical limits come from your loan program, the property’s occupancy and your LTV. For example, FHA family sales typically cap the loan at 85% of appraised value, with exceptions. Ask your loan officer to confirm the numbers before you set a price.

Who pays taxes on a gift of equity?

The donor handles gift-tax reporting. If the gift exceeds the annual exclusion ($19,000 per recipient for 2026), the donor files Form 709 and the excess reduces the lifetime exemption. The buyer does not report the gift as income. The seller may also owe tax on gain from the bargain sale, so both sides should consult a tax professional.

Who is eligible to give a gift of equity?

For conventional loans, the donor must be a relative or have a qualifying family-like relationship, such as a domestic partner, fiancé(e) or former relative. The donor cannot be tied to the builder, developer, real estate agent or another interested party in the sale.

Can a gift of equity be used on an investment property?

Freddie Mac says gifts are not eligible for investment property mortgages. Fannie Mae’s guidance covers principal residences and second homes. If you are buying a rental, ask us about other financing paths.

What should the gift of equity letter include?

The letter states that the gift need not be repaid, gives the gift amount, identifies the donor and the donor’s relationship to you, lists the donor’s address and phone number and carries the donor’s signature. FHA also asks the buyer to sign and date it.

Sources