Life Estates and Gifts of Real Estate Equity
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. Life estates and gifts of real estate equity are both types of immediate transfers of ownership that require acceptance from the new owner, and may result in tax consequences.
A gift of equity occurs when a property owner sells property to a buyer (usually a friend or family member) for a price that is significantly lower than the fair market value of the property. The difference between the price paid and the fair market value is considered to be a gift to the buyer.
The seller simply agrees to take less net proceeds at closing, which allows the buyer to have instant equity in their new property. Because the transfer of ownership and use of the property are immediate, taxes are due on the transfer.
A life estate, on the other hand, does not require payment of any purchase price. A transfer on death deed also does not require money to be paid. These types of transfers may be considered to be a gift, and they may allow the property to avoid going through probate to complete the transfer of ownership. 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.
Potential Benefits of Granting a 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
Potential Risks of Granting a 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.
Potential Advantages of Gifting Real Estate 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.
Potential Downsides of Gifting Real Estate 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 are seeking legal assistance with estate planning, probate, real estate transactions, adoption, business law, bankruptcy or debt settlement, please don't hesitate to reach out to the experienced team at Limitless Law PLLC. We're here to help.
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