As real estate prices continue to rise, it’s becoming increasingly challenging for buyers, especially young first-time buyers, to save enough for a down payment.
Fortunately, there are several alternatives to the traditional savings approach. One effective option is the use of gifts of equity, which can be a valuable resource for family members, particularly children looking to purchase their family home. Let’s see what that entails.
What is equity?
Equity in a house refers to the value held in the property, often viewed as net worth associated with it. Specifically, equity is the difference between the home’s market value and the outstanding mortgage balance.
As mortgage payments are made and the property’s value increases, equity grows. Thus, the more the mortgage is paid down and the higher the home’s value, the greater the equity becomes.
What are gifts of equity?
Gifts of equity involve transferring a property from one family member to a child or close relative at a reduced price. This allows parents to provide financial assistance to their children by offering a portion of the equity they hold in their home under certain conditions.
The gift of equity can serve as a partial or complete substitute for the down payment needed to purchase a property. It can allow the recipient to acquire the family home without needing to make financial contribution upfront.
The reduction in price compared to the market value reflect the value of the gifts and acts as the buyer’s down payment. To validate the gift of equity, a professional appraisal of the property’s market value is required.
A gift between family members
A non-repayable gift from a close family member, such as a parent, sibling or grandparent, is considered a traditional down payment, though it is less common than personal savings. While these gifts can be used for purchasing a new home, gifts of equity specifically applies to acquiring a property that is already owned by a family member.
Making a gift of equity in Quebec: how does it work?
A gift of equity is possible only if the donor, usually the parents, has equity in their home. In this case, the property is sold for less than its market value, with the difference between the two prices representing the gift of equity transferred from the seller to the buyer. This gift can then serve as a down payment, allowing the buyer to avoid using their own funds.
Gifts of equity can be used for a variety of properties, including primary residences, secondary homes, rental properties, and land. Furthermore, this approach can often be paired with other financial assistance programs available to buyers, such as the First-Time Home Buyers Incentive the Home Buyer’s Plan (HBP).
Bank conditions
Several rules apply to gifts of equity. Most financial institutions require that these gifts occur strictly between family members.
Additionally, the market value of the property must accurately reflect its fair price; it cannot be artificially inflated to increase the gift amount. To ensure an accurate valuation, financial institutions usually hire a certified appraiser to provide an objective assessment of the property’s worth.
The gift letter
Financial institutions may require a gift letter signed by the donors before accepting the application. This letter serves to confirm that the funds are a gift and do not need to be repaid. Additionally, it must clearly outline the established market value of the property and the sale price that reflects the amount of the gift.
How's the amount of the gift of equity calculated?
The amount of the gift of equity is determined by the difference between the property’s market value and the established sale price.
For instance, if the market value of the house is assessed at $350,000 and it is sold for $315,00, the gift amount would be $35,000. This represents a down payment of 10% of the property’s value.
If the gift exceeds 20% of the property’s value, more than $70,000 in this example, the buyer may be exempt from needing a mortgage loan insurance.
There is no set obligation for the gift; it can be as little as 5% of the property’s value of any other amount agreed upon by family members. Additionally, the buyer can combine the gift with their personal savings to enhance their down payment.
Gift from a parent to a child: the importance of fair market value
In any real estate transaction, including those between family members, the sale must reflect the fair market value of the property. Fair market value is defined as the highest price that could be achieved in an open market value, where both buyer and seller are informed, knowledgeable and acting independently.
While a gift of equity allows a family home to be sold ‘’at a discount’’ to provide funds for a down payment, the transaction must adhere to the fair market value of the property. Inflating the home’s value or undervaluing the sale price to benefit either party can lead to tax penalties for both.
Relying on the municipal assessment value is also inadvisable, as it often does not accurately reflect the true market value of the home.
To determine the market value of the family residence, hiring a certified appraiser from the Ordre des évaluateurs agréés du Québec (OEAQ) is the best approach. The appraiser can provide an accurate assessment of the property’s current value, allowing family members to make an informed decision regarding the amount to allocate for the gift of equity.
Tax impact of the gift: is it taxable?
Transferring a home between close relatives not only allows for a purchase without a down payment, but it also provides an exemption from the welcome tax. When a property is transferred between direct descendants, such as parents and children, the new owner is exempt from paying transfer duties, leading to significant savings.
From a taxation perspective, the tax authorities view the difference between the sale price and the actual market value as a gift. As a result, there are no tax penalties associated with the gift. Additionally, if the property is a primary residence, any capital gain realized upon the sale will not be subject to taxation.
What about the sale of a secondary residence?
In contrast to a primary residence, the sale of a secondary residence is subject to capital gains tax. While the gift of equity itself does not incur a tax penalty, parents who sell their secondary home to their child will be responsible for paying taxes on any capital gain realized from the sale.
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