What Is a Gift Letter?
A gift letter is a piece of legal, written correspondence explicitly stating that money received from a friend or relative is a gift. Gift letters frequently come into play when a borrower has received assistance in making a down payment on a new home or other real estate property. Such letters confirm that the money received is not expected to be repaid in any form.
Key Takeaways
- A gift letter declares that money received from a friend or relative is a gift.
- It’s crucial for paying a real estate down payment because lenders typically don’t approve additional borrowed money for this purpose. However, gifts are acceptable.
- Financial institutions may require gift letters before approving a loan.
- The estate and gift tax exemption for 2022 is $12,060,000 per individual, rising to $12,920,000 in 2023.
- Gift letters usually contain information about the donor, a statement that the funds are not to be repaid, and the donor’s signature.
How Gift Letters Work
Gift letters are critical because lenders dislike borrowers using additional borrowed money for down payments on homes or properties. Money given as a gift, however, is treated differently. A gift letter confirms that the money is a gift, not a loan. The gift-giver must write the letter, often detailing their relationship with the receiver.
A gift can include various forms:
- Cash, check, or other tangible items
- Transferring a title to stocks or real property without any exchange of value
- Forgiving debt
- Below-market loans
Gifts over a certain yearly amount may be subject to income taxes if given to someone other than a spouse or qualified charity. Gift letters, which must be signed by the donor, legally bind the parties to the claims stated.
Gift Letter and Additional Gifting Strategies
Gifting strategies often involve gift letters. For example, inter vivos gifting occurs while the individual is still alive, which can reduce the taxable estate since the person no longer owns the given property. The estate and gift tax exemption for 2023 is $12,920,000 per individual, up from $12,060,000 in 2022.
Many people choose to gift assets expected to appreciate significantly, such as real estate, to exclude its potential future value from the donor’s estate. However, if assets already have appreciated significantly, the recipient retains the donor’s tax basis on the property. In contrast, if a recipient inherits assets, the tax basis would adjust to the fair market value at the donor’s death.
Gift Letters and Mortgages
Gift letters are common in real estate transactions. For instance, if a parent provides $100,000 to their child for a house down payment, the lender will likely require a gift letter. This ensures the money is a gift, not a repayable loan. Both the donor and recipient may need to sign the document as part of the home loan qualification process.
Lenders may request gift letters if they notice abnormal or large transactions in the borrower’s account.
Contents of a Gift Letter
Although there is no universally accepted template, a typical gift letter must include:
- The donor’s name
- The recipient’s name
- The donor’s contact information including address, phone number, and relationship to the recipient
- The exact amount of the gift, or the estimated value for non-cash items
- The date the gift was given or received
- A statement that the funds are a gift and not to be repaid
Do Gift Letters Get Reported to the IRS?
The IRS often requires written substantiation for charitable contributions. These gift letters relate to donations or items given without any return considerations.
Why Do Lenders Require Gift Letters?
Lenders use gift letters to understand the financial obligations of the borrower. A gift is different from a loan, impacting the financial assessment of the borrower. Lenders require a gift letter to verify the terms and the nature of substantial sums received by the borrower.
Are Gift Letters Legally Binding?
Yes, a gift letter is legally binding. Both the donor and recipient are expected to adhere to the letter’s terms, impacting several financial parties.
The Bottom Line
A gift letter is a documented, signed confirmation that money given by one party is indeed a gift, not to be repaid. Such letters are often necessary for securing home loans or mortgages, particularly when large sums are transferred in advance of real estate purchases.
Related Terms: Down Payment, Mortgage, Tax Exemption, Gifting Strategies, Estate Planning.
References
- Internal Revenue Service. “What’s New - Estate and Gift Tax”.
- Internal Revenue Service. “Estate Tax”.
- Internal Revenue Service. “Frequently Asked Questions on Gift Taxes”.
- Cornell Law School Legal Information Institute. “26 U.S. Code § 2035 - Adjustments for Certain Gifts Made Within 3 Years of Decedent’s Death”.
- Internal Revenue Service. “Instructions for Form 709 (2021)”.
- Internal Revenue Service. “FAQs - Gifts & Inheritances”.
- Internal Revenue Service. “Publication 551 (12/2018), Basis of Assets”.
- Internal Revenue Service. “Property (Basis, Sale of Home, Etc.)”
- Internal Revenue Service. “Charitable Contributions Substantiation and Disclosure Requirements”, Page 1.
