Question about equity of your home.....?

We bought my husbands mothers house 3 years ago. Apparently the house was worth 185,000, and she sold it to us for 165,000...so she gave us the gift of equity. What does that mean? I honestly don't think the house was worth the 185,000 when we bought it, but when it got appraised the summer before, it might have been worth that much. Well somehow now we owe 175,000 on the house....and the houses in our sub. are all selling for 120-125,000. We are screwed basically if we want to sell our house. But, what does this "gift" of equity mean? We received a letter addressed to my mother in law that had a copy of the gift, and some paper work that needs to be filled out by her regarding it? It says is the info on the attached gift letter accurate? She told us we could open the mail that is sent here, and either discard it or bring it to her attention if it is important...just FYI. Thanks!!