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Life Estates and Gifts of Real Estate Equity

July 8, 2016

When preparing to pass on your home or real estate to a loved one, your estate plan does not have to be your only option. You might consider transferring the property during your lifetime through either a Life estate or a Gift of Equity. Both a Life Estate and Gift of Equity are immediate transfers of ownership that require acceptance and would result in immediate taxes.

A gift of equity occurs when a family member sells property to another family member for below the sale price. The difference between the price paid and the listed price is considered an amount of equity to be used toward the down payment or to help pay off debt to qualify. The seller simply agrees to take less net proceeds at closing, which allows the buyer to have instant equity while providing no down payment. Because the transfer of ownership and use of the property are immediate, taxes are due on the transfer. A Life Estate does not require consideration, nor is it a taxable transfer if there is no consideration. A transfer of death deed does not require consideration. It is to all purposes a gift similar to an inheritance except it does not need to go through probate to effect the transfer. A beneficiary takes the property subject to all conveyances, encumbrances, assignments, contracts, mortgages, liens, and other interest to which the property is subject to at the transferor’s death.

PROS of Life Estate

  • The beneficiary can make sure that they are getting the full value of the property by having a property interest, can prevent waste on the property
  • Especially beneficial because either would require that the liabilities against the property would transfer upon death
  • Don’t have to worry about coming up with as many alternative beneficiaries because the beneficiary determines who gets the property if they pass away first

CONS of Life Estate

  • The beneficiary can encumber the property with loans, liabilities, etc. because they are an owner of the property and their creditors can go after the property
  • Cannot change your mind and counts against the gift tax maximum
  • If the house needs to be sold, would be almost impossible because the buyer would only get it for your life unless the beneficiary agrees to sell their right to the property as well.
  • May impact ability of beneficiary to get government benefits because their assets would include the property.

PROS of Gift of Equity

  • Is a complete Purchase and Sale of the property and control and living on the property is not delayed by the life of the Original Property Owner
  • A gift of equity refers to the gift provided by the seller to the buyer in the form of existing home equity. In this type of scenario, there is no exchange of funds. The seller simply agrees to take less net proceeds at closing, which allows the buyer to have instant equity while providing no down payment.
  • Original Property Owner received consideration, although under market value, for their home.
  • Seller may pay buyers closing costs.
  • Buyer does not have to provide down payment.

CONS of Gift of Equity

  • Still requires Qualifying for a Mortgage for purchaser.
  • Additional restrictions based on Mortgagor; For Fannie Mae, Freddie Mac, jumbo and VA mortgages, the gift must come from a member of your immediate family (including your spouse, domestic partner or fiancé) or close extended family (grandparents, aunts or uncles). With an FHA mortgage, the gift can come from any of those sources or the following: A close friend who wants to see you do well; An employer; A labor union; A government agency; A public entity such as a nonprofit that provides homeownership to families of low to moderate income first-time home buyers.
  • A gift of equity is not allowed when the seller is an estate. This is even true when the buyer is family of the deceased. This will not take the place of a transfer on death deed or a life estate.
  • Gifting equity credit to a family member in a FHA transaction may have tax consequences for the seller because it involves giving away something of value; there is an annual exclusion to the gift tax of $13,000; therefore, the seller may give the borrower a gift valued up to $13,000 without gift tax conseuences
  • The only way a gift of equity works is if there is actual equity that already exists.

If you have questions or concerns about transferring property, call Limitless Law PLLC at (360) 685-0145 or use the “Ask an Attorney” link on our website to contact us today!

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