Selling A House To A Family Member: A Guide

If you want to keep the home with your kin, it’s very possible to do so, but there are social as well as tax implications of selling a house to a family member. Read this post to avoid any major pitfalls.

Why Selling A Home To A Family Member Is Different

You may have sentimental reasons for selling to a family member that don’t exist in a traditional home sale between unrelated parties. Chances are good that you’ve chosen to work with them because there’s a strong sense of love and trust between you. However, you want to be careful as well. A home sale can cause cracks in that trust if either party feels taken advantage of.

To minimize the potential for animosity, work with professionals at every stage of the transaction to make sure everything is above board. You may or may not work with a real estate agent if you’re buying from a family member, but it’s probably a good idea to have a real estate attorney to draw up the contract.

A buyer will want to have both an appraisal and inspection done. The value of the house may or may not affect the sales price, but both parties will know what it’s worth. You have the home inspection done because even if your family has every intention of not deceiving you as to the condition of the home, you can only disclose what you know about. Go in with full knowledge.

Questions To Ask Before Selling To A Family Member

If selling to a family member is a possibility, there are several questions you should both answer before determining whether and how best to move forward.

Is The House A Gift?

Before we go any further, it’s important to note that the next few sections touch on taxes. This isn’t intended to be personal tax advice. Please speak to a tax professional.

The first thing you need to figure out is whether you want the house to be a gift. If it’s a gift, there’s not really a sales transaction, but there is a transfer of ownership. There are a couple of things to consider here. We’ll discuss gift tax in detail in a minute, but the thing I want to briefly go over is the impact on capital losses.

The IRS doesn’t want people to manipulate gifting to offset capital gains and avoid tax liability for the sales of other properties. As a result, you lose the ability to deduct losses on a property if you discount or gift that property to a family member. All ability to take a gain or loss transfers to your family member at the time they move on from the property.

You could also trigger additional red flags if you discount the property enough to keep the proceeds under the capital gains exemption for certain primary homes. That rule allows you to deduct $250,000 ($500,000 if married filing jointly) from your capital gains if you’ve owned the home and used it as your primary residence for at least 2 out of the last 5 years before selling.

Are Both Parties Comfortable With The Taxes They’ll Pay?

When you sell to a family member, there are some special tax considerations, and you want to make sure that both parties are comfortable with them.

The IRS may take a closer look at the sale because it’s considered a non-arm’s-length transaction. In a regular arm’s-length transaction, the parties have no relationship to each other. In a non-arm’s-length transaction, that relationship exists.

Beyond that, sellers may have to pay capital gains tax, depending on how they occupied the property, how much profit (if any) they make on the sale, their tax filing status and taxable income. If you hold the property for a year or more, it’s treated at preferential tax rates of 0%, 15% or 20%. If you hold the property for less than a year, it’s taxed at ordinary income rates.

The other issue is gift tax. We’ll get there now.

Will There Be A Gift Tax To Pay?

If you’re gifting the property in whole or giving a discount on the sales price (gift of equity), there are gift tax implications associated with that. To the extent that gift tax may be required to be paid, the liability is with the donor rather than the receiver of the gift.

However, it’s a fairly high threshold to actually owe gift tax. This is because there are both annual and lifetime exclusions.

The level of the annual exclusion for the 2024 tax year is $18,000. If you file jointly with the spouse, double that amount. Gifts up to the exclusion don’t need to be reported to the IRS. Moreover, the exclusion applies to each one, so if you want to give $18,000 to each of your children, you can do so without needing to report it.

If you go beyond the annual level, it just counts toward your lifetime gift and estate tax. We hope this doesn’t happen, but to give you an idea, if you were to pass in 2024, the lifetime limit on gifts and inheritances before having to pay tax is $13,610,000.

What we’ve discussed so far are federal tax rules. You should also be aware of any additional tax liability you may have at the state or local level. However, that’s beyond the scope of this post. We’ll just say that these regulations may not match IRS policy and your tax liability may be higher or lower than at the federal level.

Can Your Family Member Meet A Lender’s Stringent Rules?

There are higher risks involved for all lenders when it comes to backing non-arm’s-length transactions. There is more potential for fraud, so more documentation may be required. For example, at Rocket Mortgage^®, it can’t be a short sale and the existing loan can’t be more than 60 days past due.

There may also be more strict financing requirements.

For example, you generally must have at least a 15% down payment on a non-arm’s-length transaction backed by the FHA. There are exceptions if this is the primary residence of a family member, fiancé(e) or domestic partner.

How To Sell A House To A Family Member Or A Friend

There are several steps to take as a precaution when it comes to selling to a family member or friend. This will help you avoid unnecessary complications or tax penalties. At the same time, it’s important to remember that state regulations vary, so the process might be slightly different in your neck of the woods.

1. Plan How You Want To Sell The Home

Your friend or family member should be involved in the process early on because you both want to be clear on exactly what’s going to happen. Here are some things you’ll want to consider.

• Professionals to hire: The first thing to think about is what professionals you want involved in the sale. This could be real estate attorneys or real estate agents as well as home inspection professionals. You can discuss who pays for what.
• The sale price: Will this be agreed to in advance or subject to some sort of professional evaluation?
• How the sale will be financed: It’s important to understand how the sale is going to be financed. There’s going to be more of a process involved with getting a mortgage than buying with cash. So you’ll both want to be clear on what to expect.
• When the sale will happen: Establishing timeline is important because mortgage lenders often want a target closing date. Everyone will want to know when to time the move. There are also tax implications with the funding of escrow accounts that are based entirely on the closing date.
• Contingencies in the purchase agreement: Contingencies provide protection for the buyer and seller because they try to anticipate what can go wrong in plan for the scenario. Appraisal, inspection and finance contingencies are often common. If anything comes up amiss at any of the stages, you have a plan for who’s responsible for what and the recourse that can be sought.

2. Get Professional Help

You’ll want some professional help because non-arm’s-length transactions can be complicated from a legal standpoint. Here’s a quick bulleted list of professionals you might get involved:

·       Real estate agent: If you’re generally agreed on selling to your family member or friend, but you want to hash out the finer points, working with a real estate agent could be helpful because they can give you an idea of what fair market value would be and help you with the contract. If you want to save some money, you could look at dual agency. We generally don’t recommend it because someone who represents both clients is inherently conflicted, but it could work since it’s not a negotiation where one party is trying to do better than the other. It’s important to note, dual agency is illegal in some states, be sure to do your research before choosing a real estate professional. You may want to hire someone with experience in non-arm’s-length transactions. If you’re agreed in terms of everything, you could hire a real estate agent just to draw up the contract for a flat fee.

·       Real estate attorney: As an alternative or in addition to hiring an agent, you could hire an attorney to write up or review the contract.

·       Home inspector: A buyer will at the very least want to know the condition of the house even if it’s not feasible to fix all the issues prior to the sale.

·       Appraiser: If the home is being financed with a mortgage, your mortgage lender will schedule an appraiser to come out anyway because they can’t lend you more than the home is worth. Even if it’s being financed some other way, it makes sense for both parties to understand the fair market value of the home.

3. Find Out The Value Of Your Home

Establishing a fair market value for your home could be crucially important when we consider the tax scrutiny that is sometimes applied to non-arm’s-length transactions. You need to show all your work so that there’s no appearance of trying to pull a fast one.

1. Start with an online estimate: This is just a ballpark estimate, but if you’re looking to get some idea of what your home is worth, you can get an online estimate.
2. Ask a real estate agent for a comparative market analysis (CMA): Your real estate agent can do a CMA. A good CMA compares your property to other similar properties that have recently sold in the area. For example, your three-bedroom ranch with a pool is compared against similar properties with adjustments for different features and the condition.
3. Get an appraisal: If the buyer is going through a mortgage lender, a professional appraisal regarding the value and basic safety of the property will be required. It’s not a bad idea to get one even if it’s being financed differently because you go in with a clear idea of the home value on both sides.

4. Settle On The Price Of The House

The single most important piece of this is setting the price of the home and finalizing the purchase agreement. The steps above on figuring out the fair market value will help you both have a baseline to start with when talking price. Beyond that, you’ll want to make sure your agent or attorney hammers out exactly what you need in the agreement.

5. Close On The Sale Of The House

The closing process involves bringing any down payment or full financing costs to the closing table along with other fees associated with the transaction. Buyers and sellers can expect closing costs to be 3% – 6% of the purchase price. This is also where you sign the official paperwork to take possession of the home. 

The closing process itself only takes maybe a few hours. The real time variable is how long it may take to get to the closing table. That could be 30 – 60 days. As we noted before, there’s a lot of extra checking on non-arm’s-length transactions, so you can speed up the process by promptly responding to a lender’s requests for information.

Selling A House To A Family Member FAQs

We’ve touched on the broad outlines of what you need to know. Now let’s tackle some questions you might still have.

What are the IRS rules for selling property to family members?

As always, consult a tax professional. However, speaking generally, if you’re selling at or above fair market value, you just need to worry about capital gains tax. If you’re gifting property or providing a discount, there are gift tax rules that apply.

How is selling your home to a family member different?

Selling to family members needs to be done very carefully because there are emotional attachments that can get messy if things go wrong. Beyond that, lenders and the IRS tend to look at non-arm’s length transactions a little more carefully because of the potential for tax or mortgage fraud. It will help to document everything.

Can my parents sell me their house for less than it’s worth?

There’s nothing to prevent your parents from selling their house to you at whatever price you both agree upon. They can even give you the house. They just need to be aware of the tax implications.

Is it illegal to sell a house to a family member?

No. It’s absolutely legal to sell a house to a family member.

The Bottom Line

Selling to a family member may seem easier because you don’t have to deal with negotiating with a stranger and you keep the house in the family, but it can be a delicate process. You have to make sure that no one feels they’re getting the raw end of the deal, causing friction for years to come. That’s before thinking of potential tax implications of gifted or discounted properties.

It’ll help to work with professionals including attorneys, tax pros and real estate agents. With real estate agents in particular, you may want someone with experience in non-arm’s-length transactions. If you feel you’re agreed enough not to need your own representation, dual agency is something you can look into.

Are you ready to move forward? We can connect you with a real estate agent who aligns on your goals.