Rules for Using Gift Funds for a Down Payment

With the holiday season of giving just around the corner, it’s a good time to revisit down payment gifts for home buyers. Getting money for a down payment on a home purchase could be the best gift ever, but there are lender and IRS rules for gifts that you must know to make sure everything goes smoothly. Here’s a rundown.

Gifts must be from family members

As an overarching rule, mortgage lenders require gifts for down payments to be from family members. Lenders might make case-by-case exceptions, and if so, will require that the relationship of the non-relative and the other factors of the loan profile be strongly compelling. For example, if you were receiving down payment gift funds from your godparents and could document that they’ve been close to you and your family all your life, that might be a case certain lenders would accept.

The likelihood of a non-relative being accepted as a gift donor is greater if a lender intends to keep that loan on its balance sheet rather than sell to Fannie Mae, Freddie Mac or some other future investor after the loan closes. Even then, most lenders would still want to see strong income history and career trajectory as well as top-tier credit scores for you as a borrower (these stronger factors of an overall profile that offset a factor where an exception is being made are known as “compensating factors”).

Gift tax is imposed on the donor, not the receiver

When starting the gift conversation with family members, make sure they know that gift tax implications are imposed on the donor. Conversely, you don’t have tax implications for receiving the gift. Two main provisions of gift tax law impact donors, and if handled properly, can enable the donor to have no tax liability, even for large gifts.

Annual gift tax exclusion limit

First, under 2014 annual gift tax exclusion law, any individual can gift any other individual $14,000 per year tax free. So a married set of parents can each give $14,000 to their single child for a total of $28,000. Or that same set of parents could gift to a married couple a total of $56,000.

This doesn’t need to be filed on annual tax returns, but you need to make sure it’s easy to document gift tax compliance later if needed. The clearest way to handle the $56,000 example is to have the mom write two $14,000 checks: one to her son and one to her daughter-in-law. Then the dad would do the exact same thing, for a total of four checks of $14,000 each. Then if the parents were ever asked by the IRS to demonstrate they were within the 2014 annual exclusion limit, it would be easy.

Lifetime gift tax exclusion limit

Second, under 2014 lifetime gift tax exclusion law, any individual can gift up to $5.34 million tax free over a lifetime. So let’s say in the example above that the married set of parents were trying to gift their married son a total of $100,000. We know that they can gift $56,000 tax free under the annual exclusion rule. The remaining $44,000 can be gifted tax free under the lifetime exclusion rule. That amount can all be transferred in a lump sum, and the donors must complete IRS Form 709 to keep a tally of gift funds that fall under the lifetime exclusion.

Both the annual and lifetime exclusions change each year. The annual gift tax exclusion limit for 2015 will remain at $14,000. The lifetime gift tax exclusion limit for 2015 is projected to increase slightly to $5.43 million.

Also for home buyers looking to buy in early 2015 with gift funds, keep in mind that as we close out 2014 and enter 2015, donors can give you funds under the 2014 annual exclusion on or before Dec. 31, then double it under the 2015 annual exclusion on Jan. 1 or later.

Gift donors must provide letter & bank statement to lenders

It’s not enough to tell your lender you’ll be getting gift funds from a family member. Lenders must track gift funds as painstakingly as they track all your other asset and income documentation.

The funds can’t just appear from your family donor, so add this topic to the list of things to talk about upfront. Here are the most important things to know:

  • You and the donor must both sign a lender Gift Letter verifying the funds are in fact a gift.
  • The letter will explicitly ask the donor to verify that the gift isn’t a loan.
  • Neither you nor the donor writes the letter. The letter will be provided by your lender, and it’s the only format that the lender will accept.
  • For most loans, donors must also provide proof of their ability to gift, usually in the form of a bank statement. There are very few exceptions, and your lender can advise on whether it will waive the requirement.

As long as donors know these lender and tax rules upfront, the process is simple. So as we enter the season of gift giving, you can use these guidelines to have planning discussions with your family.