This article will help you understand the basic tax implications of giving a downpayment gift.
For many people, the downpayment is a significant barrier to homeownership. For most mortgages, you need roughly 5% to 10% of the purchase price to secure the loan. That means $5,000 to $10,000 for every $100,000 in home value. A $500,000 home? The buyer needs roughly $25,000 to $50,000 to make the purchase!
Yes, there are zero-down options, but they are limited. VA loans, for example, are only available to eligible veterans and their family members. USDA loans are for making a purchase in certain locations, namely rural and suburban areas.
Most people will need a downpayment, which is required in addition to closing costs, appraisal costs, realtor fees, and more. Purchasing a home, even when you are borrowing, comes with high upfront costs.
Recognizing this problem, many generous family members want to help by giving a large financial gift. This eases the burden on a buyer, and can mean a home purchase for your loved one.
But what are the tax implications of these large gifts? If you are going to give a significant financial gift worth tens of thousands of dollars, you should understand how this generosity will impact your tax bill.
What to Know About Giving Gifts
Note: We are NOT Tax Experts
This article is intended for general advice and entertainment only. We’ve done our best to make it as accurate as possible to our best knowledge, but the information is not intended as tax advice in any way. Tax law is constantly changing, so always seek the advice of a qualified expert before making any decisions.
Gift Givers Pay the Tax (Not the Recipients)
It’s important to understand that if you give a large cash gift, you will be responsible for paying federal taxes on this gift. This is important to consider, as you will be financially responsible for the tax payment and should take this into account when making any decisions.
No Federal Taxes Until $11.58 Million in TOTAL Giving
Under the current federal tax code, you do not have to pay gift taxes until you reach a total of $11.58 million in gifted cash or other assets. This is in total throughout your entire lifetime. This lifetime exclusion was raised to $11.58 million by Congress and signed into law by President Trump during the most recent tax revision.
If you are married, this lifetime exclusion is for both partners; your spouse is entitled to tax-free gift-giving up to $11.58 million as well. This means that combined, and when organized properly, you and your spouse can give over $23 million throughout your lifetimes.
This means that, for most people, the gift tax is basically a non-issue. Most individuals, even over the course of their entire lives, will not approach $11 million in gift giving. However, you may have to file gift tax returns in order to not owe money to the federal government.
Annual Gift Exclusion Creates Additional Tax Protection
A federal gift tax exclusion, which is allowed annually, lets you give up to $15,000 in a single year to as many people as you desire. All of this $15,000 was allowed in 2020 and it did not count against your lifetime total of $11.58 million. This total will likely be increased in the future to account for inflation.
Suppose you gave two relatives $20,000 each, while you gave a third relative $10,000. The two $20,000 gifts are taxable gifts because they are over the $15,000 limit, but you won’t actually owe taxes on that until you reach the lifetime limit. The $10,000 gift, however, is entirely ignored since it’s below the $15,000 threshold.
Gift Taxes are Tied to Estate Taxes
Currently, you have a $11.58 million federal estate tax exemption, so you can leave up to that amount to anyone and it will not be taxed by the federal government. (Reminder: if you’re married your spouse also gets an exemption of $11.58 million.) However, gifts made during your lifetime can reduce your taxable estate while gifts in excess of the annual exclusion will reduce the taxable exemption.
Certain Gifts are Tax-Exempt, But Not a Downpayment Gift
While many gifts come with tax implications, there are others that are completely exempt from federal gift taxes. If your gift falls under a certain category, you can essentially make unlimited gifts in these areas without any taxes applied.
Tax-exempt gifts include certain charities that have been approved by the IRS, as well as gifts to your own spouse. It also possible to give gifts to help cover another person’s medical bills and not have these gifts included as a taxable gift. If you give a gift that helps cover another person’s tuition and education, this gift is likely tax exempt. However, the payments need to go directly to the educational institution.
A Downpayment Gift Letter Will Likely Be Needed
When giving a gift that will be used for a downpayment, you’ll likely need to provide a “gift letter.” Essentially, this letter tells the lender that the money being gifted is not a loan and, therefore, will not need to be repaid. The lender obviously has a vested interest in ensuring that the borrower is not taking on another financial burden by assuming another loan.
Remember that when someone is purchasing a home, they can only use cash gifts from an immediate relative, such as a parent, grandparent, or sibling. If the downpayment gift is over $15,000, you will need to report it in on your taxes. The gift must be filed to track your lifetime amount, which is then used to calculate your taxes when it comes time to distribute your estate.
Secure the Mortgage You Need Today!
If you are using a financial gift to make your San Diego home purchase, or if you want to give a downpayment gift and want to make sure it can be used towards a mortgage, contact our staff today.
With decades of experience in the mortgage industry, we can help you find the right home loan for your specific needs.
