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Gifted Money To Pay Student Loan Debt | Will I Have To Pay Gift Tax?

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In a Nutshell

When you’re just starting out, a significant gift from a family member or other loved one can make all the difference. For instance, a gift that pays off all or part of your student loans or, the gift of down payment funds may help you buy a home and begin building equity. If someone has offered a generous gift but you’re worried about gift tax, income tax, and other tax issues, here’s a quick rundown of what you need to know.

Written by the Upsolve TeamLegally reviewed by Attorney Andrea Wimmer
Updated June 7, 2021

When you’re just starting out, a significant gift from a family member or other loved one can make all the difference. For instance, a gift that pays off all or part of your student loans may give you greater freedom to take a lower-paying job that will help build your career. Or, the gift of down payment funds may help you buy a home and begin building equity. 

Most people don’t fully understand the taxes associated with this type of gift. If someone has offered a generous gift but you’re worried about gift tax, income tax, and other tax issues, here’s a quick rundown of what you need to know.

Gift Tax Rules

The first thing you need to know about gift taxes is that they’re paid by the gift giver, not the recipient. If your parents gift you $40,000 to pay off your student loan debt or make a down payment on your house, you don’t have to pay taxes on that money. But, your parents may owe taxes on some or all of that amount. 

Federal gift tax can be as high as 40%. But, with a little planning, paying this tax may be avoidable. Most states don’t have gift taxes, but a few do. So, make sure you know the rules in your state.

Does the Recipient Ever Pay Gift Tax? 

There is one exception to the rule that the giver pays the tax on gift funds. If the person who gave you the gift doesn’t pay the tax and they’re required to do so, the recipient may ultimately be responsible for the unpaid tax.

Annual Gift Tax Exclusion

The first line of defense against having to pay federal gift tax is an “annual exclusion.” Each individual can give each other individual up to $15,000 per year, tax-free. That amount is doubled for married couples. For example, each of your parents can give you $15,000/year without paying gift tax. In other words, they can give you $30,000/year tax-free. That limit is imposed per recipient. Your parents can give $30,000/year tax-free to each of your siblings too, and to pretty much anyone else they choose.

Note that gifts involving “future interests” are treated differently. But, that won’t come into play with a gift of cash or payment of a debt on your behalf. 

So, in the example above, your parents could gift you $30,000 of the $40,000 without paying gift taxes. But, what about the remaining $10,000? A second layer of protection may make that amount tax-free, too.

Unified Gift and Estate Tax Exemption

Most U.S. estates aren’t taxed at the federal level. That’s because the Internal Revenue Code exempts a significant portion of an individual’s estate. As of 2021, that amount is $11.7 million per individual. The combined exemption for a married couple is $23.4 million. This means that only a tiny percentage of estates are large enough to owe any tax at all. 

In fact, most people won’t need anywhere near that exemption amount to protect their full estates. So, the IRS allows taxpayers to use some of that exemption in advance, by claiming it as a gift tax exemption. In other words, each person gets a combined lifetime $11.7 million exemption. The IRS doesn’t care whether you use it during your lifetime to avoid taxes when giving gifts, save it all up to avoid estate taxes, or split it up. 

The first $15,000 (per year) from each gifter to each recipient doesn’t count towards this lifetime exemption. That money is covered under the separate exemption discussed above. But, if one individual gives another a larger gift, the excess may be treated as exempt as part of the $11.7 unified exemption. It’s up to the giver whether to take that exemption or save it for later. It’s a good idea to get advice about that from an accountant or financial planner before committing to a decision either way. 

If they don’t use the exemption, they’ll owe gift tax on the amount over $15,000 to each person gifted within a given tax year. 

Gift Tax Return

Not everyone who gives a gift has to file a gift tax return (IRS Form 709). Only some individuals are required to file gift tax returns. Note that if a married couple gives a gift jointly (and they are required to file this form), each must file a separate gift tax return. Gifts made from community property are 50% gifted from each spouse.

An individual must file a gift tax return if they:

  • Gave gifts totaling more than $15,000 to someone other than their spouse during the tax year

  • Gave a gift of any amount involving future interests, meaning the recipient won’t actually receive or get to use the gift until some future date

Note that you must file the gift tax return whether or not you plan to use part of the unified credit to exempt the gift from taxation.

Gift tax returns are filed annually, with the same deadline as individual income tax returns. If you receive an extension of time to file your income tax return, the deadline for filing your gift tax return is automatically extended to the same date.

The Difference Between A Loan And A Gift

Within families and among close friends, the lines between a gift and a loan may get blurry. When the exchange of money involves more than $15,000 in a year or will be used as a down payment on a house, clarity counts. 

A parent may be inclined to offer  an open-ended loan with little or no interest and a “pay me back when you can” outlook. While that’s generous, this approach can backfire. If a loan isn’t formalized, the IRS may view it as a gift. A contract may seem unnecessary between parent and child, siblings, or close friends. It may even be uncomfortable to ask the borrower to sign a contract. But, documentation is a key step toward proving that a loan is in fact a loan. 

Signing a note isn’t necessarily sufficient, though. It’s just one piece of the paper trail. A fixed repayment schedule and documentation of payments is the best way to ensure that a loan to a friend or family member is treated as a loan. You should also know that interest-free loans and low-interest loans can create a different problem. While there are exceptions, interest waived may, in and of itself, be treated as a gift. 

Each month, the IRS publishes Applicable Federal Rates (AFR) for loans. If a loan is interest-free or the interest rate is below the AFR, the uncharged interest may be treated as a gift. That doesn’t necessarily mean the lender will owe gift tax, since the amount may fall below $15,000 or be exempted with the unified credit. 

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How To Use Down Payment Gift Funds From A Family Member

You might think that your mortgage lender won’t care where your down payment has come from. But, if you’re planning to use gift funds to make your down payment, some documentation will be required. That’s because you generally can’t use borrowed funds for a down payment. If you suddenly have tens of thousands of dollars in your bank account to make a down payment, the mortgage lender will want to know where it came from. If you claim that the funds are your own, some lenders will require past bank statements to prove that the money didn’t recently appear all at once.

Depending on the type of loan, a friend or family member may be able to give you that money. But, the person providing the funds will typically have to provide the lender with a gift letter. The letter itself isn’t complicated, and your lender may be able to provide you with a simple template. The gift letter describes your relationship with the giver and certifies that no repayment is expected. Secretly agreeing to repay the money is mortgage fraud.

Government-backed loans - those offered by agencies like the USDA, VA, and FHA - tend to allow greater flexibility. USDA and VA loan regulations allow down payment gifts from a wide range of sources. Nearly anyone who is not an interested party can make a down payment gift. Interested parties are those affected by the purchase, like the seller or the mortgage lender.

The FHA loan standard is slightly more restrictive, but still allows down payment gifts from many sources. These include: 

  • Family members

  • Friends (which may include extended family members)

  • Employers

  • Labor unions

  • Charitable organizations

Conventional loans are a bit tougher. Conventional mortgage lenders tend to have the most restrictive underwriting requirements. That’s true even when those loans are backed by Fannie Mae or Freddie Mac. Typically, they will only allow down payment gifts from family members, including your fiance or domestic partner.

Gift Money For Student Loans

Unlike mortgage down payment gifts, student loan repayment gifts are unrestricted. Your lender doesn’t care where payments come from. Even a partial repayment of student loan debt can make a tremendous difference to a recent graduate. But, it’s important to manage the gift strategically.

Many people make extra payments to their student loan servicers - either as the result of a gift or from their own funds - with mistaken expectations. How extra payments are treated depends on the terms of your loan. That means your experience may be different from a friend’s or relative’s. 

Extra payments may be applied to principal, to interest, or to future payments. If you don’t specify, your extra payment will be applied according to the terms of the loan. But, you may be able to direct the servicer to apply it differently. The best application depends on your specific circumstances. For example, applying the gift to principal can lower the long-term cost of the loan significantly. That means that you will pay less overall and may be able to pay off the loan sooner. 

Let’s Summarize...

A gift from a friend or family member can be life-altering. If homeownership is your goal, the gift may allow you to buy a house sooner than you imagined. Or, a cash gift may help pay down student loan debt to manageable levels. But, it’s important to understand the law, tax implications, and other regulations relating to gifting before you either give or receive such a generous gift. That’s especially true when considering a mortgage down payment gift. Educate yourself about gift taxes and other gift-related rules before you move forward.

Written By:

The Upsolve Team

Upsolve is fortunate to have a remarkable team of bankruptcy attorneys, as well as finance and consumer rights professionals, as contributing writers to help us keep our content up to date, informative, and helpful to everyone.

Attorney Andrea Wimmer


Andrea practiced exclusively as a bankruptcy attorney in consumer Chapter 7 and Chapter 13 cases for more than 10 years before joining Upsolve, first as a contributing writer and editor and ultimately joining the team as Managing Editor. While in private practice, Andrea handled... read more about Attorney Andrea Wimmer

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