Selling A House To A Family Member: Everything To Know

If you’re thinking about buying a house, you may be considering purchasing a home from a family member. Or maybe a family member has expressed interest in buying your home. But it’s important to understand that selling a house to a family member can operate differently from a traditional sale to a stranger.

By knowing what to expect, you can simplify and manage a process that may become complex and emotionally charged.

Why Is Selling A Home To A Family Member Different?

Home sales between family members differ from the typical home selling process because the federal government has rules regarding how much family members can gift in equity. The Internal Revenue Service (IRS) also wants to prevent potential fraud in family sales.

At one time, many more families paid substantial estate taxes. However, the 2017 Tax Cuts and Jobs Act doubled the estate tax exclusion, drastically reducing the number of taxable estates.

The IRS assumes most sellers will prioritize furthering the family’s interests rather than their individual own self-interest. To overcome that presumption, a seller must prove the sale functioned as if it were between strangers.

Arm’s Length Vs. Non-Arm’s Length Transactions

The IRS trusts that strangers will act in their own interests. But when the buyer and seller are related, it can raise a red flag for the IRS and other federal agencies. They may suspect the buyer’s long-term financial interests align with the seller’s interest.

The government distinguishes between real estate sales involving related and unrelated parties. The transactions fall into two distinct categories:

When you sell a home to a family member, the IRS examines the home’s sale price to determine whether the sale meets fair market value or qualifies as a gift.

What’s Your Goal?

Home Purchase

Home Refinance

Tap Into Equity

Why Does The Government Care About Selling A Home To A Family Member?

When done correctly, a non-arm’s length transaction is perfectly legal. The IRS looks more closely at them because they present a higher risk for fraud or tax avoidance. However, the government’s interest in reviewing family sales goes beyond taxes.

Negative Implications For Local Real Estate Values

Local governments depend on property taxes from real estate. If the value of a property is artificially depressed, it can reduce the amount of property tax revenue the government can collect. It can also affect real estate transactions of nearby properties.

Let’s say your home is worth $500,000, and you sell it to your child for $300,000. Now, your former next-door neighbors want to sell their home. But they may not get their $500,000 asking price because the real estate comps show that your home sold for substantially less.

Medicaid Fraud

Homeowners involved in elder planning may attempt to avoid nursing home costs by “selling” their property to a child while they continue to live in the home. The homeowner thinks that by transferring ownership, the home will be safe.

However, most states have 5-year look-back periods. If a homeowner gifts or sells a home below market value and applies for Medicaid 5 years after the sale, the state may penalize them, making them temporarily ineligible for long-term Medicaid care.

How To Sell A House To A Family Member

Follow the steps we’ve outlined and consult a real estate attorney to make sure you follow all related tax laws. Keep lines of communication open between you and your family member throughout the process.

1. Establish The Home-Selling Process

You and your relative must agree on the logistics of the sale, including how you’ll execute any decisions. To help eliminate future conflict or confusion, you should lay the groundwork for the sale in advance. You may want to discuss the following:

Ultimately, both parties should stay on the same page so each person knows what to expect during the home selling process.

2. Hire A Real Estate Agent For Professional Help

Hiring a real estate agent or real estate attorney can help iron out the process for both parties. They can enforce contracts and fees, draw up the paperwork, identify required property disclosures, review important documents and ensure the home sells at fair market value. A good real estate agent can additionally counsel clients on what constitutes a good offer and what’s negotiable.

A professional can serve as a buffer between you and your family member, keep the process objective and offer valuable advice, especially when both parties are new to real estate. The goal is to make the sale a more streamlined and smoother process.

3. Determine The Home’s Fair Market Value

A neutral third party should estimate your home’s value. A home appraisal can provide a professional estimation of your home’s current market value – which may have changed since you first bought it. Either you or your family member can pay for the home appraisal.

Your real estate agent can also run a comparative market analysis using the multiple listing service (MLS) to help determine the home’s fair market value.

4. Set A Reasonable Price

From the government’s perspective, getting the sales price right is the first major hurdle to clear. You should stick fairly close to the comps as proof of value when setting the price unless you want to take advantage of the gift tax exemption.

Even if you aren’t working with a lender, consider getting an independent appraisal to support the sale price or work with a real estate agent to generate relevant comps. It’ll provide valuable documentation if the transaction ever comes under scrutiny.

5. Close On The House

Closing on a house with a family member may look different compared to when you originally closed on your home. Consider hiring a lawyer to verify the accuracy of all closing documents.

If your family member buys the home with a mortgage loan, the lender will require a traditional closing that involves a title company.

Tips For Buying A House From Family

Before you sell or buy a house from a family member, consider applying these steps as you move through the real estate sale.

Put Everything In Writing

Because many family sales are completed without a real estate agent, you must be diligent about paperwork. Save organized notes of the sale’s terms and agreements to help prevent misunderstandings and make the process much easier for the title company.

Hire A Home Inspector And Appraiser

You should always order a home inspection before a home sale. A certified home inspector will take a look at the home to identify health hazards, safety concerns or major mechanical defects.

Home inspections benefit home buyers and sellers. It protects a buyer from purchasing a home with major problems, such as roofing, plumbing or electrical issues. If the inspection report comes back with no significant issues, a seller can use the report as leverage if the buyer wants to renegotiate the sale price or purchase terms.

The buyer’s lender will require an appraisal to confirm the home’s value meets or exceeds the loan amount.

Double-Check Your Compliance With Tax Laws

If you don’t follow the law, the IRS may accuse both parties of trying to avoid capital gains tax. You must follow the IRS gifting laws if you sell your home for less than its fair market value. Your tax attorney can help you understand the relevant gift laws.

Again, it’s best to hire a tax attorney to ensure you and the buyer follow all tax laws.

Keep Emotions At Bay

Selling your house to a family member can be more emotionally fraught than selling to a stranger. For example, the established sale price may lead to conflict or misgivings.

One common mistake sellers make is to treat the sale more casually than a traditional sale to an outsider. They may ask for too little and then end up strapped for cash later. They may regret asking a family member for an amount far below market value.

Make financial decisions based on logic rather than emotion and keep the process formal. Insist on putting standard procedures in place, such as:

Understand The Limits On Gifts Of Equity

You can choose from two main methods to price a home sale to a family member: make a gift of equity or sell the home at fair market value. If both parties aren’t careful, a gift of equity can result in significant gift tax implications.

When you make a gift of equity, that means you’re selling property to a family member for less than its current market value. The gift of equity is the difference between the home’s current market value and its selling price.

When you sell a house for less than its fair market value, you must report the difference as a gift to the IRS. Under IRS rules for the 2023 tax year, you can give up to $17,000 as a gift of equity before you pay gift taxes. As the seller and gift giver, you must pay the gift tax if it exceeds the limit.

The thought of paying a gift tax to sell a home to a family member may discourage some sellers. There are also other drawbacks to consider, such as legal fees (a gift of equity requires a contract) and possible capital gains taxes.

Selling A House To A Family Member FAQs

The following are answers to frequently asked questions about selling your house to a family member.

The Bottom Line: Conduct The Real Estate Transaction As If It Were Arm’s Length

Understanding why the government closely scrutinizes non-arm’s length transactions can help you avoid future financial problems by following all relevant rules. Additionally, making sure to hire professionals to help streamline the process can reduce relationship issues between family members.