Accounting Terms & Definitions - Vyde

What is Gift of Equity? in Real Estate Deals

Understanding ‘What is Gift of Equity?’ Learn how family members can sell property below market value, impacting real estate transactions. Dive into its significance and potential tax implications for buyers and sellers.

What are Gifts of Equity?

A gift of equity is when family members sell property to other family members for less than market value. The gift of equity is specifically the difference between the market value and what the buyer pays. A gift of equity can be for any amount, up to the total value of the home.

Gifts of equity don’t necessarily have to be from family members. Anyone who you’ve had a relationship with can qualify for a gift of equity.

Most lenders will allow the buyers to use the gift of equity as the down payment for the purchase. Both the buyer and the seller must sign an equity letter.

A gift of equity can have tax implications for both parties. The seller may have to pay capital gains taxes on the gift of equity. The buyer’s asset cost basis would be based on the market value not what the property was purchased for.

Gifts of Equity Scenario

Jack is looking to buy a home. His grandparents are preparing to downsize and are offering to sell him their home. Jack’s grandparent’s home appraised for $250,000. Jack can’t afford to pay that right now.

To help Jack out, his grandparents are offering to sell him their home for less than market value. Jack can pay $190,000 for his grandparent’s home. His grandparents agreed to sell him the home for $190,000.

Because Jack is related to the seller and they’re selling the house for less than market value it qualifies as a gift of equity. The gift of equity is for $60,000, which is the difference between the market value and what Jack is buying it for.

When Jack goes to get his loan he will submit an equity letter from his grandparents stating the amount of the gift, that there are no repayments expected or required and the donor’s information.

Another bonus of the gift is that Jack won’t have to put down a down payment because the $60,000 gift of equity qualifies as his 20% down payment.

Jack will have to meet any other requirements the financial institution where he gets his loan at requires to document the gift of equity.

A gift of equity offers an avenue for family or certain relationships to facilitate property transactions below market value. It serves as a significant financial benefit, allowing buyers to potentially use it as a down payment, minimizing upfront costs. However, it’s crucial to note the potential tax implications for both parties involved—the seller may encounter capital gains taxes, while the buyer’s asset cost basis aligns with the property’s market value. Despite its advantages, understanding the intricacies and tax considerations is vital before utilizing a gift of equity in real estate transactions. Always consult with professionals and adhere to the requirements of financial institutions when applying this concept in property purchases.

1. Who can provide a Gift of Equity?

Family members or individuals with a relationship can offer a gift of equity. It involves selling property to others below market value, with the difference acting as the gift.

2. How is a Gift of Equity utilized in real estate transactions?

Lenders often permit using the gift of equity as a down payment. Both buyer and seller must sign an equity letter detailing the gift’s value.

3. Are there tax implications associated with a Gift of Equity?

Yes, both sellers and buyers may face tax implications. Sellers might encounter capital gains taxes, while the buyer’s asset cost basis depends on the property’s market value.

4. Can anyone besides family members provide a Gift of Equity?

Yes, individuals with an established relationship can qualify for a gift of equity, enabling property transactions below market value.

5. How does a Gift of Equity impact down payments in real estate purchases?

A gift of equity can serve as a down payment. For instance, if the gift represents 20% of the property’s value, the buyer may not need additional down payment funds.

What is a Federal Tax Lien?

A federal tax lien is used to put a lien on property, or any other assets, as collateral for unpaid back taxes. The Internal Revenue Service (IRS) can issue federal tax liens to secure payment of those unpaid back taxes.

A federal tax lien does not allow the government or the IRS to seize any assets. The government has to issue a tax levy in order to seize any property.

When the IRS places a federal tax lien, they tell all states and creditors that they are placing a lien and they are first in line for any payments. If a federal tax lien is placed against you, it will significantly lower your credit.

You can learn more about how federal tax liens can affect you on the IRS’ website.

Federal Tax Lien Scenario

Doug is a small business owner. He hasn’t paid his personal taxes in five years. The IRS has filed a federal tax lien against Doug to try and get him to pay his back taxes.

The first step the IRS will take will to be to notify Doug’s other creditors; the federal tax lien takes precedence over any other creditors. Then, the IRS will place the federal tax lien against his bank accounts, car, home and against his small business business. Although Doug has paid his business taxes, the IRS can still hold a lien against his small business for payment on his personal taxes . Once the federal tax lien is issued it will also lower Doug’s credit score. This will make it more difficult for Doug to take out any new loans.

Doug have three options in order to have the federal tax lien removed. The first option is to pay off the debt in full. The second option is to get the debt dismissed in bankruptcy court. Finally, debtors can reach a settlement with the IRS to pay or forgive the debt.

Doug is the sole proprietor of his small business so it is considered an asset that the IRS can go after when trying to get him to pay his back taxes. If Doug decides to choose to declare bankruptcy the IRS will asses if his business to determine if it has any value. If they determine that there is value in the business, then it can be taken. However, if there isn’t value in the business then the IRS won’t go after it and Doug could continue to run his business after the bankruptcy.

In order to make sure he can still run his business, Doug chose to pay his back taxes. The IRS will release the lien 30 days after the debt it paid in full.

Frequently Asked Questions

1. What is a federal tax lien?

A federal tax lien is a legal claim made by the Internal Revenue Service (IRS) on your property and assets due to unpaid back taxes. This lien serves as collateral to ensure payment of the owed taxes. While it does not allow the IRS to seize property, it establishes the government’s priority over other creditors for payment.

2. How does a federal tax lien affect my credit score?

When the IRS places a federal tax lien against you, it notifies all states and creditors, establishing its priority for any payments. This action significantly lowers your credit score, making it more challenging to secure new loans or credit. The lien remains on your credit report until the debt is fully paid or resolved.

3. Can the IRS seize my assets with a federal tax lien?

No, a federal tax lien itself does not grant the IRS the authority to seize your assets. For asset seizure, the IRS must issue a tax levy. A lien simply secures the government’s interest in your property as collateral for the unpaid taxes.

4. How can I get a federal tax lien removed?

There are three primary ways to remove a federal tax lien:

Pay the Debt in Full: Once the debt is fully paid, the IRS will release the lien within 30 days.
Bankruptcy: In some cases, debts may be discharged through bankruptcy, potentially removing the lien.
Settlement: You can reach a settlement with the IRS, such as an Offer in Compromise, to pay a reduced amount and have the lien removed.

5. Can a federal tax lien affect my small business?

Yes, if you are a sole proprietor, your small business is considered a personal asset and can be subject to a federal tax lien for your personal unpaid taxes. The IRS can place a lien on your business assets, affecting your ability to operate. In the case of bankruptcy, if the IRS determines your business has value, it may seize it. However, if the business lacks significant value, you might be able to continue operating post-bankruptcy.

What is the Earned Income Credit?

The Earned Income Credit (EIC) is a tax credit for low to moderate income earners. In order to qualify for the Earned Income Credit, you must file a tax return, even if you are not required to file taxes. Those who file for an Earned Income Tax Credit may receive a tax refund if their taxable income is less than the credit.

Qualifications for the Earned Income Credit include:

Earned income by working for someone else, or by owning your own business
Meet the rules for a qualifying child
Meet certain income levels (You can find those levels on the IRS site.)
File as Married filing jointly, Head of household, Qualifying widow or widower, or Single. If you file as married filing separately, you do not qualify for the Earned Income Credit.

Earned Income Scenario

Jerry and Ellen Johnson are husband and wife; they have two children. Jerry works for an established company as a contractor and Ellen just started her own Etsy business. Together, Jerry and Ellen earn $50,000 a year.

The Johnsons file as married filling jointly on their personal taxes. This means that they file their total income on one tax return. Jerry and Ellen claim the Earned Income Credit because they earn less than the two child max of $50,198 a year.

By filing for the earned income credit they are able to lower their taxable income on their personal taxes. They may even be eligible for a tax refund after they count any other deductions or credits.

The Earned Income Credit only applies to Jerry and Ellen’s personal taxes. When Ellen files her business taxes for the business she owns she will not include the Earned Income Credit.

What is a Tax Deduction?

A tax deduction is a credit that is subtracted from your income, which lowers your taxable income. The Internal Revenue Service (IRS) allows taxpayers to take a standard deduction or an itemized deduction.

A standard tax deduction is set by the IRS each year. Taking a standard tax deduction doesn’t require any record keeping or proof of deductions. It’s the simplest way to take deductions. Standard deductions are only available on personal taxes.

While the standard deduction is easy, it’s not always the best option. An itemized tax deduction allows you to calculate all of the deductibles that you qualify for, which could be higher than the standard deduction. The IRS offers deductions for the following categories:

Health care costs (medical, dental, prescription drugs)
Income taxes or sales taxes
Property taxes
Mortgage interest
Personal property taxes (like vehicle registration fees)
Interest on investments
Charitable contributions
Losses due to theft or casualty
Job-related expenses
Union dues
Tax preparation fees
Home office expenses
Gambling losses

In order to take an itemized tax deduction, you must keep detailed records so that you can prove you are eligible for the deductions. For business tax deductions you must do an itemized deduction; there is not a standard deduction.

Tax Deduction Scenario

Doug Chambers is a small business owner, who runs a creative business out of his home.

Doug takes advantage of tax deductions each year to lower his taxable income and to save money. Because he is a home owner, Doug can take a deduction on his property taxes and his mortgage interest. He also has a family insurance plan. All of these can be claimed as deductions on his personal taxes. Because Doug runs his business out of his home, he can claim his home office as a tax deduction. He can also claim his marketing & advertising costs and unpaid invoices as business deductions.

Doug has two options for his personal taxes, he can take the standard deduction of $9,350, which is the standard the head of household deduction. Or because Doug qualifies for several deductions he can choose to do an itemized deduction.

If Doug chooses to do an itemized deduction he needs to provide his accountant with all his records so that they can determine if claiming the itemized deduction will be more beneficial.

Because business taxes only allow standardized deductions, Doug must provide documentation for each of the deductions he wants to take.

Overall, Doug is able to lower his taxable income for his personal and business taxes.

What are Charitable Donations?

What are charitable donations?

Charitable donations are gifts given to nonprofit organizations. Charitable donations can take many forms. Common gifts include:

Money
Real Estate
Vehicles
Clothing
Securities
Jewelry
Other Assets or Services

Most charitable donations are tax deductible. In order to qualify for a tax deduction the nonprofit organization has to be classified with the IRS as 501(c)(3). You can double check that the organization you are donating to is tax deductible through the IRS Exempt Organizations Select Check.

It’s important to get a receipt from the organization that you donate to in order to claim it on your taxes.

One aspect of charity that is not tax deductible is volunteering. The IRS does not allow you to deduct hours you spent volunteering because it is too hard to track. However, you can deduct traveling expenses like gas, oil, air or bus fair. You must be able to provide receipts in order to deduct it.

Businesses and individuals can make charitable donations. Both can claim charitable donations on their taxes.

Charitable donations scenario

Mike Johnson is a realtor. He is a partner at Sunrise Realty. Every year Mike makes charitable donations through his business and on his own.

individually Mike donates to:

His church
Make A Wish Foundation
PBS

His business donates to the following organizations:

Vetrans Association
Boys and Girls Club
A local Children’s Hospital
The local fire station
Sponsor a local t-ball team

On Mike’s personal taxes he can claim all of the donations as charitable donations because all of the organizations are classified as 501(c)(3) with the IRS.

On Sunrise Realty’s taxes Mike and the other partners can claim, all except sponsoring the t-ball team as tax deductible. Most sport teams don’t qualify for tax deductions; however, some may be registered, so it’s important to look at each team individually. Because Mike’s local team doesn’t qualify as a charitable organization, he is able to write it off as a marketing expense.

What are Business Tax Credits?

Business Tax Credits are a group of credits available to business owners. Business Tax Credits include:

Investments
Work opportunities
Welfare-to-work
Employer provided day care services
Research and experimentation
Low-income housing
Enhanced oil recovery
Health insurance premiums

These tax credits are grouped together and submitted through IRS Form 3800.

The IRS limits how many credits you can claim each year. The limit is calculated by your tax liability. You can use IRS form 6251 to find out how many credits you can claim each year. If you go over your credit amount then the credits will be held and you can use them the following year.

Business Tax Credits Scenario

Dr. Jared Andrews is a general practitioner, who owns his own family practice. Dr. Andrews has 15 employees. He provides health insurance and day care services for his employees. He also has multiple business investments.

Because Dr. Andrews has multiple items that qualify for the business tax credit he will combine them on IRS form 3800.

Dr. Andrews takes advantage of business tax credits by filing the health insurance premiums, day care services and his investments. Because he claims more than one of the credits he files IRS form 3800.

Claiming these business tax credits allows Dr. Andrews to save money by paying less taxes. He can then spend that money on building his business.

FAQs: Understanding Business Tax Credits

What are business tax credits?

Business tax credits are incentives provided by the government to reduce the tax liability of businesses. They include credits for investments, work opportunities, welfare-to-work programs, employer-provided daycare services, research and experimentation, low-income housing, enhanced oil recovery, and health insurance premiums.

How do I claim business tax credits?

Business tax credits are claimed by filing IRS Form 3800. This form allows businesses to group together various eligible credits and apply them against their tax liability.

Are there limits to how many business tax credits I can claim each year?

Yes, the IRS limits the number of credits you can claim each year based on your tax liability. You can use IRS Form 6251 to determine your credit limit. Any credits exceeding the limit can be carried forward to the following year.

How can business tax credits benefit a business owner?

Business tax credits reduce the amount of taxes a business owner has to pay, allowing them to save money. These savings can be reinvested into the business, such as by expanding operations or improving employee benefits.

Can you provide an example of how business tax credits are used?

For example, Dr. Jared Andrews, who owns a family practice with 15 employees, provides health insurance and daycare services. He combines these credits with his business investments on IRS Form 3800, reducing his tax liability and saving money to reinvest in his practice

What is After-tax Income?

Define: After-Tax Income

After-tax income, also referred to as income after taxes, is the amount of disposable income that a person or company has left over after all federal, state and withholding taxes have been deducted from the taxable income. You can spend your after-tax income on future investments or on present consumption.

After-tax income isn’t as scary as it sounds. So, what is after-tax income really? It’s simply your wages after you have paid all of your taxes.

After-Tax Income Scenario

Jenna is a photographer; she runs Jenna’s Photography Studio; therefore, according to the IRS Jenna is self-employed. Because she is self-employed, Jenna should set aside 30% of her profits for taxes. The 70% left over after paying taxes is the after-tax income.

Jenna has a lot of options on how she can use her after-tax income.

If she wanted to invest her after-tax income into her business, she could buy new lighting equipment, or she could use the money to buy advertising for her business. The great thing about investing the money back into your business is that you’re able to write off most of those expenses as tax deductions.

Jenna may choose to use her after-tax income for personal reasons. Because she’s self-employed her after-tax income is her salary. It can go towards paying rent, bills or for a vacation.

There are no restrictions or laws on what you can do with after-tax income. It’s your money to spend.

Resources

Category: Accounting Terms & Definitions

What is Gift of Equity? in Real Estate Deals

What are Gifts of Equity?