Is selling a home to a family member a good idea?

Selling a home to a family member is not as simple as money changing hands between a willing buyer and a home seller. The home-buying process can be a complicated one with issues such as potential tax implications or family difficulties. That’s why it’s best to get legal assistance while going through the transaction. 

Did you know, only about 8% of people actually sell their house to a relative? If you too want your home to be legally bought by your son, daughter, brother, or grandchild, you’d of course want to know if you can sell the house to a family member. And, what are the legal requirements? 

While it’s completely legal to sell a house to a family member, taking fraudulent action or misleading the IRS to avoid taxes on the sale is illegal. The IRS needs to have a correct record of the taxable value the buyer received. You, the seller, must properly disclose your home’s fair market value, the sale price, and details of the financing.

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How is selling a home to a family member different? 

The government views real estate transactions between relatives differently than a traditional buyer-and-seller relationship. To understand this, you’ll need to understand the difference between an arm’s length transaction and a controlled transaction. 

An arm’s length transaction is when you sell your house to a person with whom you have no personal connections. A home appraisal dictates the market value and guides the listing as well as the sale price. Both parties enter into a fair purchase agreement, seeking the best terms and price for themselves. 

A controlled or non-arm’s-length transaction is one where you sell to someone you know off the open market. The buyer and seller agree on a purchase price regardless of the real estate market conditions. 

If the seller sells the home for an amount that’s much beneath its market value, the IRS considers this as a taxable gift that needs to be reported during the sale. Plus, you’ll need to supply additional documentation to explain why you sold the home at a price substantially lower than the market value.   

Keep in mind that the IRS carefully views all controlled transactions for any signs of fraud such as gift tax evasion or capital gains tax evasion. 

What is the gift tax?

Selling your home to a relative will make you liable to pay a gift tax. You can give up to $16,000 per person in a year without paying the gift tax. However, any gift that costs more than $16,000 is taxed at a rate of 18% to 40% – depending on the amount given. 

If you’re looking for ways to avoid paying the gift tax, you may apply the excess of your gift over $16,000 toward your lifetime gift and estate tax exemption.

What is capital gains tax?

Giving or selling your house for less than it’s worth raises the likelihood that the giftee may be subject to capital gains taxes. This is due to the fact that the recipient’s tax basis is determined by your tax basis. If you’re looking for ways to minimize your relative’s capital gains tax, it’s best if you leave the house to them in your will and let them inherit it. An inherited property doesn’t have to face the same taxation laws as a gifted property.

How to sell your house to a family member: The steps

When it comes to selling your home to a family member, you may want to make sure that everything is legal with some forethought and preparation, and a little legal assistance.

Agree on the home-buying process and timeline

Both parties need to sit together and discuss the entire process so that there’s no confusion and conflict down the line. 

Bring in professionals

More often than not, money can be the cause of a rift between family members. Even if you share a good relationship with your relative, a major financial transaction such as buying a home can cause unnecessary tension and disagreements over sale contracts and fees. 

While you may not need a real estate agent for the conventional purpose of finding a house, you’ll still require a professional to ensure that all the paperwork, the purchase contract, property disclosures, and any other legalities are handled well. 

You’ll also need a real estate attorney to help you draw up key documents, an appraiser to handle the home appraisal if the buyer is applying for a mortgage, and a tax professional to determine the buyer’s tax liability.

Get the home value evaluated

Your realtor will provide you with a comparative market analysis, determined by the appraisal and a professional home inspection.

Reach a selling price

The next step would be to reach an agreement on the sale price guided by the professional(s). This is also when you explore the various options for the buyer to finance the purchase. You’ll need to draw a purchase contract that includes the sale price, all the relevant contingencies, timelines, and loan terms.

Close the deal

Be ready to have a traditional closing if the buyer has taken a loan to buy that piece of real estate. 

How to buy a house from a family member

If you’re intending to buy a house from a family member, it’s important to protect your own interests while protecting those of the seller as well. Just make sure that it’s indeed the right home for you or else it won’t be worth it. While buying a family member’s house to help them out financially may seem like a generous act, you need to evaluate your financial situation and decide whether buying the real estate makes sense for you or not.  

Read more: Should you buy a house during a recession?

Get a price estimate from a professional

A home seller may believe that their house is worth more than it actually is. You, the buyer, need to understand its monetary worth. To avoid getting into a bad bargain, it’s best to get an impartial third party to analyze the house’s condition and its fair market value. They will examine neighborhood comps and recent home sales in the area to tell you if you’re getting the best price or not.

Get legal representation

Buying a home involves a lot of documentation, regulations, and potential pitfalls. It’s a good idea to hire a lawyer to make sure that both sides are getting a fair deal. They’ll even handle issues such as contingencies in the purchase contract and review the title for liens. An attorney will also push for state-required property disclosures. And ensure that both parties are abiding by local, state, and federal regulations.

Hire a home inspector

This can give you a lot of peace of mind. The home inspection report will give you the real picture – the actual condition of the house and if there are any issues that might affect the sale price.

What factors should you consider before selling a house to a family member? 

If you’re emotionally attached to a house, selling it to a relative gives you some happiness to know that the property will remain in the family. And will be cared for. 

However, you need to understand the tax implications and regulations. Before going ahead with the transfer of ownership, you’ll need to accept a few things:

• You will not make as much money as you would if you list your home on the open market 
• If you fail to report the house sale, it could raise red flags with the IRS. 
• You’ll have to fully comprehend the tax laws and the tax liability for you or the buyer. It’s best to consult a tax expert and make full disclosure of the transaction. 
• There’s a chance of your personal relationship with the buyer going sour if there’s any financial disagreement over price or contract terms.   

What are the disadvantages of selling a home to a family member?

Selling a property to a family member or a friend may pose problems that may not even arise during a traditional home sale.

• The IRS will scrutinize you for possible tax evasion. You cannot ever misinterpret the tax laws or else you’ll be in trouble with the IRS. 
• You may not get the desirable price if you’re selling the house to a relative at a discounted price. A traditional sale would fetch you more money.
• There could be family issues, a fallout, or even a botched transaction if the deal doesn’t go as planned. 
• There are more steps of verification in transactions between family members, especially by the lender. This could delay the deal closing. 

Last thoughts

Generally speaking, it’s never a good idea to mix business with family. However, selling your home to a relative may sometimes make sense –  financially or in terms of convenience. Do keep in mind that selling real estate to a family member is not as simple as inheriting it after your relative’s death. The home-buying process and the tax implications are a lot more complicated. Moreover, if you sell a house for an amount that’s much less than its market value, it can be considered a gift of equity and may put a tax liability on the buyer. And, will require additional tax documentation. As a home seller, it’s not always the best decision to sell to a family member.

Written by Ramona Sinha. February 7, 2023

Ramona is a content writer for Kukun. This experienced blogger uses simple and succinct words to decipher the complex phenomenon called life. An avid traveler, she’s a digital nomad at heart and an animal lover from the depths of her soul.