How do I purchase property from family below market value?

Question

Hello everyone!

I have recently began preparing to invest in real estate, and am trying to understand the best way to purchase a home from a family member below market value. I have done some reading, and I understand the concept of a "gift of equity", which I think could allow me to use some existing equity as a down payment for my own mortgage on the property.

Here's what I am thinking:

Appraised Value: $140,000

Family member's mortgage balance: $90,000

I purchase for: $112,500 (Pay off $90,000 mortgage, plus $22,500 down payment (20%) from gift of equity)

Cash out of pocket: Closing costs

Equity after closing: $140,000 - $112,500 = $27,500

I am wondering if anyone is familiar with this process, especially in MN, and could let me know if that scenario makes sense. Also I'm hoping to shed light on the following questions. I understand I will need to consult a CPA and likely an attorney, but I'm hoping to have a general understanding before starting those conversations.

- Would the gift of equity in this deal (according to IRS) to be $22,500 (purchase price less existing mortgage) or $27,500 (appraised value less purchase price)?

- Would my family member have a gift tax liability? I understand there is an annual exclusion amount for gifts, but if you are under the lifetime unified credit amount, are you excluded from a gift tax?

- How quickly could I use a HELOC against my gained equity to fund another real estate purchase?

I would greatly appreciate any thoughts, advise, or stories on this subject, and look forward to discussing and contributing to the great resource that is Bigger Pockets!

Thanks!

Dylan

Bill B. · Answer

It SOUNDS like they are giving you a gift of $27,500 off the fair market value. And then giving you another gift of the $22,500 from $112,50 purchase price down to $90k for a total gift of $50,000? Unless that $22,500 is coming out of your pocket or you’re paying them back, it sure sounds like a $50k gift. Pretty nice family member giving you $50k, I think I got $500 one time, might have been at my wedding

Second, a heloc of 75% on $140k is only $105k, so an additional $15k may not be worth the hassles to either you or the bank.

John Woodrich · Answer

Gift = Appraised value less liabilities assumed = 140k - 90k = $50k gift. Would need to file a gift tax return to report the gift. No tax would likely be due.

Your first step in doing this should be to talk to a lender and see how they are going to treat the gifts. Wouldn't surprise me if they wanted to see you come to the table with some form of cash. You don't mention what you plans are but you will still need to meet the DTI criteria on the new mortgage.

I agree with @Bill Brandt on the LOC, I wouldn't be doing it to get $15k. The amount may allow for a low down payment purchase but remember - you would have to live in those properties to purchase under those terms. This plan involves you taking on 2 mortgages - another reason to talk to a lender. Send me a message if you want a recommendation.

Dylan Hardy · Answer

Thanks for the response Bill!

They are a pretty awesome family member, I appreciate them very much. I am wondering if the IRS gift amount would depend on their existing mortgage value, or just the market value and purchase price. You are correct that they would be giving $50,000 in equity.

As for the HELOC, is the process typically a hassle? My thought is that the $15k or so would allow me to purchase another property with an FHA or 5% conventional mortgage.

How do I purchase property from family below market value?

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