Lenders will accept a gift of equity, defined as sale price below current value, as the equivalent of a cash down payment. Gift taxes can usually be avoided by following IRS rules.

"My parents are willing to sell me their home, which is worth $200,000, for only $150,000... Can I arrange the sale in a way that will allow me to avoid mortgage insurance and gift taxes?"

You avoid mortgage insurance if the loan amount is 80% of property value or less. Lenders will accept your parent’s gift of equity of $50,000 as the equivalent of a cash down payment, provided that they are satisfied that the house is really worth $200,000. They probably will require two appraisals rather than the customary one because the sale price was set within the family rather than through arms-length bargaining.

Gift taxes should not be a problem. Taxable gifts are those to one recipient in excess of $12,000 per year. (Gift recipients never pay taxes on gifts). If you are married and have at least one child, each of your parents could gift each of the three of you $12,000 a year, or $72,000 in all, without it being taxable.

If you are married but have no children, your parents can give you and your wife only $48,000 in non-taxable gifts in any one year. The remaining $2,000 you need would be a taxable gift, but your parents don’t pay taxes on it. They must report it on IRS Form 709, and it will be deducted from their “unified credit” of $345,800, which is the total amount of credit against gifts allowed during their lifetime free of tax. This credit will shield up to $1 million in gifts.

For further information, see IRS Pamphlet 950.

Copyright Jack Guttentag 2007