Santa may decide to be extra generous this year by pulling out a whopping check to put down on a new home. It is perfectly acceptable to have your down payment come in the form of a gift, but certain stipulations apply. Below is a summary of the rules you need to know if you are the giftor or the giftee:
Only Family Members Can Provide the Gift
In practice, most mortgage lenders will require that your down payment gift come from someone directly related to you. Depending on the circumstances, some lenders may make an exception. If your gift comes from someone close, but not related to you, you will need to provide compelling evidence that this person has been a part of you and your family’s life for many years.
If the lender intends to keep the loan on its balance sheet, rather than selling it to Freddie Mac, Fannie Mae, or another future investor, the odds are higher that a gift from a non-family member being accepted. Even if the non-family member gift is accepted, most lenders will still require an excellent credit score and strong income history with future earning potential before offering you a loan.
The Giver is Responsible for the Taxes, not the Receiver
If you’re the lucky giftee, make sure the giftor understands that the gift tax will be imposed on them, rather than you. There are two facets of gift tax law that will affect the giver, but with proper handling, they may have no tax liability, even if their gift is large. Both are quickly summarized here:
Annual Gift Tax Exclusion Limit
Based on the 2015 annual gift tax exclusion law, any single individual may give another individual as much as $14,000 annually free of tax. This limit will remain the same in 2016.
The basis of this law can be used to your advantage if your parents are providing a gift to you, especially if you are married. Each parent can give you $14,000, for a total of $28,000. If you have a spouse, your parents can each give both of you $14,000, for a total of $56,000.
You don’t actually need to file this gift on a tax return, but it’s best to keep a record of it handy in case you need to document gift tax compliance later. The simplest way to keep a clean record is to have each parent write two checks to their child and the spouse, each for $14,000. So in the end, you would have four separate $14,000 checks.
Lifetime Gift Tax Exclusion Limit
The second part of the gift tax exclusion law pertains to the total amount an individual may gift without tax during their lifetime. For 2016, this total was raised to $5.45 million. This law can be helpful in the case that your potential gift exceeds the limits defined above. Say that your parents wanted to give you $100,000. The first $56,000 of this sum can be given tax free based on the annual tax free exclusion rule. The remaining $44,000 can still be given tax free based on the lifetime exclusion rule. In order to do this, the givers would need to complete the IRS Form 709. This will allow them to tally the gift amounts covered by the lifetime exclusion.
Gift Givers Must Provide Proper Documentation to Lenders
If you plan to use a gift as a down payment, your lender will require quite a bit of documentation. Banks track gifts as closely as they do your income or the assets. Several steps need to be completed to use gift funds:
- The letter will be written by your lender; no other form of letter will be accepted
- Both must sign confirming that the funds are in fact a gift and not a loan
*Some lenders may have additional requirements.
After all the red tape and interrogations of Santa, I’m sure there’s not much complaining to do for such a generous gift. Contact me to find out the best use of it for your situation.
Happy Holidays!