What Is a Gift Letter? Understanding This Tax Benefit

If you’re in the market for a new home, getting a large cash gift couldn’t come at a better time. Traditionally speaking, whenever a down payment was made on a house, it was usually done so in conjunction with money from a wedding gift. 

The process was pretty cut and dry, allowing newlyweds to pick out a home, get some financial assistance from family, and move in. Today, however, things aren’t so black and white. If you’re going to be getting money for whatever reason to go toward buying a new home, you’re going to need some information from the gift giver in the form of a gift letter.

In this guide, we’ll discuss the particulars of receiving large cash gifts and how it affects you when buying a home. 

Gift Letters and Mortgages

The principles of a gift letter are in themselves pretty straightforward, as it’s just a note from the giver that states their donation doesn’t have to be paid back. Why is this letter necessary in the first place? Well, if you’re going to be using a large financial gift to help pay for your mortgage, whether in part or whole, your mortgage company needs to know that it’s not a loan. 

With that said, sometimes gift letters aren’t enough, and more evidence needs to be presented to your mortgage company. Oftentimes, the size of the gift dictates what your lender will want to see verified, such as whether the funds are available from the donor or if they’ve been transferred to your bank account.

As such, you may want to inform whoever is gifting you money that your mortgage company might want to see documentation. This will give you time to collect the necessary information if it is requested from you. 

What’s on a Gift Letter?

Fortunately, gift letters are easy enough to write up. Your gift donor will need to include the following information when drafting their letter:

  • Their name, address, and phone number
  • Their relationship to you
  • Total amount of gift
  • Fund transfer date
  • Their statement*
  • Their signature
  • New address*

*The donor’s statement needs to clearly explain that the monetary gift they are giving you is not a loan in any way, shape, or form. This includes details that they don’t expect this gift to be paid back. The new address portion of the gift letter needs to be the address of the new property that you are buying (and will be using the gift to help pay for it).

Depending on your mortgage company, they might provide a gift letter template if one is requested. While the above information should be sufficient for most gift letters, your lender may have different needs. As such, you should ask them if there is anything that specifically needs to be on the gift letter if a template isn’t given to you.

Why Are Gift Letters so Important?

The main reason has to do with federal regulations that mandate a buyer’s DTI (debt-to-income ratio) be considered by lenders. Loan agencies use your DTI to determine whether you are a good candidate for paying back what you borrow.

The IRS and government also want to know whether the person or persons giving the gift are adhering to gift tax laws to eliminate possible money-laundering operations. This is only a formality, so as long as you and your donor are on the up-and-up, you have nothing to worry about.

Timing Is Everything

While you’re likely excited to pad your bank account with monetary gifts from, say, a recent wedding, you might want to think twice before depositing them. Why? It all depends on what you’re trying to accomplish.

If you plan on trying to qualify for a mortgage, having more money in your bank account than what you normally have could cause you problems. If your mortgage company requires a history of assets (often 60 days), a large cash deposit could become an issue if you don’t have a gift letter ready to show them.

This could result in approval delays if you don’t time your deposits just right. As such, you should contact your mortgage company ahead of time to iron out the details so that everything goes smoothly.

What Gift Amounts Require a Gift Letter?

If you just got married, there’s a good chance that you received monetary gifts of various amounts. While a $50 check isn’t likely to be questioned, a $5,000 one most certainly will. To determine what gift amounts will need a gift letter, let’s look at various lenders’ requirements.

Conventional, FHA, VA, jumbo, and USDA loans all have unique guidelines for what they consider a large deposit. The FHA (Federal Housing Authority) and USDA (United States Department of Agriculture) both define a large deposit as being greater than 1% of the appraised value or adjust purchase price (whichever one is lower).

The other loan types view a large deposit as any monetary amount that is greater than 50% of the person’s total monthly qualifying income. 

Let’s assume for a moment that you make $2,000 a month and are applying for a conventional loan. If your lender sees a deposit into your bank account of more than $1,000, their underwriter will probably want evidence of its origins. 

Using the $5,000 wedding gift from a moment ago, it’s safe to assume that the underwriter is going to need to confirm that large amount as being a gift and not a loan. 

With that said, it’s more than possible for smaller amounts to be questioned, as well. It all depends on the underwriter working on your mortgage. If any deposit seems out of the ordinary, most underwriters are going to ask questions.

This is because your payment and deposit history is carefully evaluated. Most people have consistent activity in their bank accounts, so if there are inconsistencies, your underwriter will catch it.

Gift Letters and Taxes

The great thing about monetary gifts (other than them being free money) is that you likely won’t have to pay taxes on them. However, it’s not uncommon for tax laws to see revisions and changes. As such, you should contact your financial advisor to ensure that you are clear on the tax implications. 

While you’re probably not going to have to worry about paying any taxes on your gift funds, the same isn’t always true for the donor. In fact, there’s a very good chance that they will have to pay taxes on the gift they give you.

To ensure that there aren’t any surprises, you might want to give your gift-givers a heads up on this likelihood. While you certainly could offer to pay any gift taxes for your donors, doing so isn’t a requirement.

In any event, the majority of gift funds are likely to go under the radar anyway. As of 2020, $15,000 is the annual exclusion amount for giving monetary gifts. Therefore, anyone giving gifts that don’t exceed $15,000 isn’t required to report it.

But if you were fortunate enough to receive a monetary gift of more than $15,000, the donor will need to file a gift tax return disclosing the amount. It’s important to note that filing a gift tax return doesn’t necessarily mean taxes will have to be paid on it. This report simply signifies that the amount given is counted toward the donor’s lifetime exclusion for gift taxes. 

At present, everyone can give a total of $11.58 million in gifts throughout their lifetime without ever paying taxes on it. And if a couple is married, they each get the $11.58 million exemption. As such, it’s very unlikely that the vast majority of people will ever reach that amount in gifts given. With that said, it still may be necessary to report your gifts via a gift tax return. 

Summary

If you or your donors aren’t sure whether a gift tax return is necessary, you may want to speak with a financial advisor. They will be able to tell you what the requirements are for giving gifts in your situation.

We hope this article helped you understand the intricacies of gift letters and their tax benefits. If you are interested in learning more about finances and business, we encourage you to check out the rest of our blog section.

We cover a wide range of topics that can help you improve your financial standing. From building credit and starting a small business to securing loans and mortgage rates, we prepare you for life’s most important decisions.

If you have any questions that our Seek Capital experts can assist you with, please feel free to contact us. We will be happy to offer our guidance and direction to ensure that you make the best decision possible for your needs. We look forward to serving you and hope to hear from you soon!

 

Sources

https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-why-is-the-43-debt-to-income-ratio-important-en-1791/

https://www.hud.gov/program_offices/housing/fhahistory

https://www.usda.gov/

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