Many families keep homes in the bloodline, passing down beloved houses from generation to generation. It’s well-known that this happens, but unless a house is inherited after death, the process is a lot more complicated than parents simply taking a dollar from their daughter as she unpacks her moving truck. You can’t just sell a house to a family member for a negligible amount.
Houses may be sentimental things, so it’s understandable why you might want to keep your home in the family and sell to a relative. While it’s legal and possible to do, there are a number of complexities that may make it a less desirable decision. From considerable tax implications to financing hoops to the strife that selling within the family may cause, selling a house to a family member may not be the best decision for you as a home seller.
The biggest distinction between selling to a family member and a typical home sale is the type of transaction required. Most real estate sales are considered “arm’s-length” transactions, meaning that the buyer and seller don’t have a pre-existing relationship.
In these types of transactions, each party…
Conversely, a “non-arm’s-length transaction” (sometimes called a controlled transaction) is one in which both parties know one another and have a pre-existing relationship. These arrangements often lead to agreements that diverge from those of the open market.
It’s not just family members who make non-arm’s-length transactions. Business partners or associates, friends, and other transactions made between people who know one another personally may raise issues.
Non-arm’s-length transactions are legal but they carry a higher risk of fraud, meaning the IRS pays close attention to them. That means you can’t simply sell your house for a dollar. The IRS will investigate the transaction to ensure that the sale price reflects the fair market value or if the seller is giving the buyer a gift by lowering the sale price. Either scenario triggers a tax event that wouldn’t happen in an arm’s-length transaction.
The IRS defines the fair market value of a home as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”
Selling a house below fair market value signals to the IRS that you are selling at a gift price. As of 2022, the annual gift limit is $16,000 for individuals and $32,000 for married couples filing jointly. This is the maximum amount that you can discount the price of your home without having to report it as a gift to the IRS.
However, even if you exceed the annual limit in a price deduction, you likely won’t have to pay taxes. As of 2022, unless you’ve given away more than $12.06 million to a single person during your lifetime, you will not have to make a gift tax payment. You do still, however, need to file a return if you go over the gift limit so the IRS can keep track of the gifts you’ve made.
A real estate agent or home appraiser, along with a home inspection, can help you determine the fair market value before considering a gift.
When you give money or an item of value exceeding the annual limit without being paid, the IRS adds this amount to your lifetime gift exclusion limit — that $12.06 million number. Most people will never reach this amount, even if gifting multiple properties. The IRS has very generous gifting rules, so you might be thinking why wouldn’t I gift my house?
Where things get complicated is with the home itself. The IRS considers a price discount on a home given to a family member a gift of equity, which subtracts from your lifetime gift exclusion limit and may never become a tax issue. But if you gift the home outright, the recipient inherits the original tax basis of the home rather than the “stepped up” tax basis that most homes earn by increasing in value. This can have negative effects on the buyer later.
If the gift recipient wants to sell the home later, they’re subject to the same capital gains tax exclusion as everyone else: Up to $250,000 for individuals or $500,000 for married filing jointly. But some sellers who received a house as a gift may struggle to stay under this amount because they inherited the original tax basis.
Here’s an example:
Tom is a widower who has decided to give his house to his daughter Melody and move in with his new girlfriend. Tom bought the house in 1970 for $150,000. In 2022, the fair market value of the home is $600,000. That represents a $600,000 gift from Tom to Melody which, fortunately, is far less than the lifetime maximum allowed of $12.06 million. Tom won’t have to worry about paying a gift tax.
However, Melody gets a new job in a new city in 2025 and can’t afford to pay the property taxes on two homes. She sells the house for $650,000, a capital gain of $500,000 (sale price of $650,000 minus the original tax basis of $100,000). Because she owned the house for more than two years, she wouldn’t normally have to pay capital gains tax. But because the house kept its original tax basis, her capital gains are far higher than what they would be if she bought the house at or near market value.
Now, Melody has to pay a large chunk of that sale back to the IRS. She still comes out ahead, but Tom’s gift may have had more value if Melody paid some money upfront for it in 2022.
Of course, this is just an example. If you’re considering selling a house to a family member, always consult a tax professional first.
While in most instances the heaviest tax implications fall to the recipient in a non-arm’s-length transaction, there are a number of other risks for sellers to be aware of.
Lenders aren’t always excited about non-arm’s-length transactions, as the potential for fraud is higher when two people who know one another exchange property. If your family member is using a mortgage to finance the purchase, a lender will scrutinize the deal closely. The lender may also have a few extra requirements such as:
While a cash sale eliminates lender involvement, you should still get an appraisal and save the paperwork. You’ll need it to show the IRS.
For many, a house is their greatest asset. Selling it could be your one opportunity to fortify your retirement fund or finance a home you want to spend the rest of your life in. Selling it below market value may seem like a generous, smart move at the time to keep the wealth in the family but how will you feel when you find your true dream home and it’s just beyond your budget?
Worse yet, selling such a huge asset always comes with stress. There’s a very real possibility that a non-arm’s-length transaction can even lead to animosity. Whether a family member expects a bigger discount or the two of you can’t agree on who pays to fix the faulty HVAC system, there are many things that can go wrong when family members negotiate. Maybe your family member makes changes to the house that you hate.
Having a personal fallout from selling a house to a family member is a risk you’ll have to take if you want to pursue this route. To help mitigate problems, it’s helpful to bring in an impartial expert like a real estate agent or attorney.
You’ve agreed to sell your house to a family member. Don’t just jump on into it. Even though you have a buyer lined up, the negotiation and closing processes can still take some time. It’s crucially important to talk through how things will go before proceeding.
You should figure out if you want to bring in an agent or appraiser (you should), discuss the buyer’s financing (if it’s not an outright gift), and set a realistic timetable. If there are multiple people involved in each party, make sure you’re all on the same page.
It’s just smart to treat a transaction between family members like a regular home purchase. A real estate agent gives you an impartial mediator in the event that issues arise during the negotiation. They’re not working for either party, they’re working for both to ensure the best deal possible gets done.
Not only that, but they’ll help you keep everything on the level. That means helping your buyer complete paperwork with a lender, ensuring all tax requirements are met to satisfy the IRS, and helping you negotiate contracts and fees typically involved in a home sale.
Likewise, it’s smart for both parties to get their own attorney. One attorney can draw up the purchase contract correctly but if you’re involved in a real negotiation, it’s better to each have an attorney representing your interests rather than sharing one.
You can probably find both an agent and attorneys who are willing to work for flat fees rather than the typical 6% commission. If both parties can agree to split the bill on the agent at least, it’s well worth the investment.
If a lender is involved, you’ll almost definitely have to get a home appraisal and inspection. Even if your family member isn’t using a lender, though, appraisal and inspection are important to do.
An agent can perform a comparative market analysis to help determine fair market value of the home. An appraisal will confirm or adjust that, giving you the paperwork defining fair market value to the IRS. That will help you and your relative negotiate a price.
An appraisal is usually paid by the buyer and typically costs $300 to $400.
You should also have the house professionally inspected just to make sure everything is in good working condition and your family member won’t be surprised by any significant repair costs after moving in. The nationwide average cost of a home inspection is $339.
Now is the time to consider all the tax implications and find the best deal that works for both you and your family member. Remember, what you paid for your house is the tax basis that your family member will inherit. If your home’s market value has vastly increased, it may behoove you to give a smaller gift of equity so your family member doesn’t get hit with a huge capital gains tax if they sell later.
Of course, your family member probably wants to purchase below market value so if you’re feeling generous, you can provide non-taxable gifts in the form of paying for the appraisal, inspection, agent and attorney fees, or any closing fees. You could also pay to make any necessary repairs to the home or make an extra-contractual agreement.
If you’re selling your home to a family member below market value, it’s important to tell the neighbors. Why? Because your sale could skew future comparative market analyses for your neighbors. Appraisers need to know that your home is an outlier among comparable properties and shouldn’t be factored into an analysis.
Your agent and attorney should make sure that your transaction is recorded as a family sale in public property records, but it’s a good courtesy to inform the neighbors in case a future appraisal feels unusually low.
Like any home sale, a sale between family members requires a purchase agreement. This contract should:
If a lender is involved, the closing process will include a title company and may legally require the presence of a lawyer.
Selling a house to a family member has obvious perks. You can find a buyer that you trust quickly, you can keep your house in the family, and you can help out a loved one. But don’t go blindly offering a discount or giving your home away outright. Between tax implications for both seller and buyer and the potential for significant regrets, you should handle selling a home to a family member with the same caution and forbearance you would with any home sale.
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