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Steps To Selling A House To A Family Member

9-Minute Read
Published on June 16, 2021

In this tight real estate market, you may be considering purchasing a home being sold by a family member.  

Or maybe you have a family member who has expressed interest in buying your home. Selling a home to a family member can involve a different process than the same transaction with a stranger.

Take a look at the following steps and tips so you can clear up any questions you have about the process of how to sell your house to a family member.

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Why Is Selling A Home To A Family Member Different?

Family home sales differ from the typical home-selling process. That’s because family members are presumed to have similar interests: avoiding taxes and shielding family wealth. 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.

Those considerations may not have anything to do with your situation – you may not be acting to protect generational wealth – but it’s the backdrop against which IRS and Medicaid rules regarding intrafamilial transfers were developed.

Legally speaking, the presumption that family members are acting to further the family’s interests – rather than their individual interest – can only be overcome if the taxpayer can prove the sale was conducted as if it were between strangers. 

Let’s take a look at what you need to do to protect yourself – as buyer or seller – from future legal difficulties or unexpected tax bills.

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Arm’s Length Vs. Non-Arm’s Length Transaction: What’s The Difference?

The IRS trusts that strangers are acting in their own interests, but if the buyer and seller are related, it’s an immediate red flag to the IRS and other federal agencies.

It’s all about whether your long-term financial interests as the buyer align with those of the seller, your family member.

Arm’s Length Transaction

In most transactions, the buyer of a home and its seller don’t know each other, and each party  acts in their own self-interest to get the best deal they can. This is called an arm’s length transaction.

In other words, if you’re the seller, you’re going to try to sell your home to the highest bidder while the buyer will try to pay as little as possible. The buyer and seller commonly meet in the middle to buy and sell a home at what’s known as fair market value.

Non-Arm’s Length Transaction

A non-arm’s length transaction, on the other hand, involves a deal between two people with the same financial interests, often tax avoidance. For this reason, you will be closely scrutinized to see if the transaction is an attempt to avoid a taxable event or to minimize future taxes.

When you sell a home to a family member, the IRS will examine the sale price of a controlled transaction to investigate whether the sale is considered a gift or if it meets fair market value.

Can My Parents Sell Me Their House Below Market Value?

It may have been a lifelong dream to “purchase” your parents’ home at a very favorable price and raise your family where you grew up. However, the IRS has strict rules about the transfer of real estate among family members.

That’s because below-fair-market-value property sales were once a common way to avoid the gift and inheritance tax. In response, the IRS started taking a closer look at these sales to spot fraudulent or “sweetheart” deals.

And if you’re borrowing from a mortgage lender to complete the purchase, they’ll require you to prove the home’s value. They’ll also require a gift letter for gifts of equity.

Why Does The Government Care About Sales To Family Members?

The IRS is not a fan of non-arm’s length transactions because they provide an opportunity for fraud or tax avoidance, but the government as a whole has interests in having the power to review these sales that go beyond taxes. When done correctly, however, a non-arm’s length transaction is perfectly legal.

Limits On Gifts Of Equity

You can choose from two primary options for setting a price when selling to family members: you can make a gift of equity or you can charge your family member fair market value for your home.

A “gift of equity” means that you sell property to your family member for a lower amount than the current market value. The gift of equity applies to the difference between the current market value and the amount for which you sell your home.

Selling at lower than fair market value means that you will have to report the gift to the IRS. Under IRS rules, you can provide a gift of up to $15,000 as a gift of equity before you have to pay gift taxes.

As the seller and gift-giver, you must pay the gift tax. You can easily identify a few drawbacks to gifting a home to a family member, including legal fees (a gift of equity requires a contract) and having to pay possible capital gains taxes.

Negative Implications For Local Real Estate Values

Local governments depend on taxes from real estate, and if the value of the property within its borders is artificially depressed, it can reduce their property tax revenue. Governments frown on reduced revenues.

For example, let's say your home is worth $500,000 but you sell it to your child for $300,000. Let's say that after they move in, your former next-door neighbors want to sell their home. They might not get their full asking price of $500,000 because the real estate comps show that your home sold for substantially less. If homes sell for less, the local government receives less in taxes.

Medicaid Fraud

Homeowners engaging in elder planning may be trying to avoid paying for nursing home costs by “selling” their property to a child – without planning to move or change their relationship to the home. The thinking is that by transferring ownership, the home will be safe.

However, most states have 5-year look-back periods. If the homeowner gifts or sells the home below market value and they apply for Medicaid within 5 years after the sale, the state may penalize them and make them ineligible for long-term care Medicaid for a period of time.

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How To Sell Your House To A Family Member

Follow the steps outlined below, and consult a real estate attorney to make sure you follow tax laws scrupulously. Keep lines of communication open between you, the seller, and your family member, the buyer, throughout the process.

Establish The Home-Selling Process

Make sure you and your family agree to the logistics of the sale and how you'll execute official decisions. Laying the groundwork for the sale in advance eliminates future conflict or confusion. You may want to discuss the following:

  • The specific professionals you may want to have help you.
  • How your family member will buy the home.
  • The timetable you want to use.
  • What should happen if other parties get involved and try to change the agreement between you and your family member.

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

Hire Professional Help

Hiring a real estate agent or real estate attorney irons out the process for both parties. These professionals can enforce contracts and fees, draw up the paperwork, identify state-required property disclosures, review important documents and ensure that the home sells for fair market value.

A good agent provides counsel on what constitutes a good offer and what is negotiable. This sentiment is especially important to keep in mind when selling a house to a family member.

A professional can serve as a buffer between you and your family member, keep the entire process objective and offer key advice when both parties are real estate novices. The sale's final result can end up being a very objective, smooth process.

Determine The Home’s Value

A neutral third party should evaluate your home’s value. A professional appraisal can offer a more educated decision on your home’s official market value – the home's value may have changed since you first bought it. Either you or your family member can pay for the home appraisal to get the home’s official value.

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.

Set A Reasonable Price

From the government’s perspective, getting the sales price right is the first major hurdle you’ll need 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’re not working with a lender, consider getting an independent appraisal to support the sales price of the home, or work with a real estate agent to generate any relevant comps. It’ll provide valuable documentation should the transaction ever come under scrutiny.

Close On The House

Closing on a house with a family member may differ from when you originally closed on your home. It's a good idea to hire a lawyer to oversee the accuracy of all closing documents.

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

Tips For Buying A House From Family

Read through the following tips before you sell your house to a family member. You may need to apply all these ideas when you move through the sale process.

Put Everything In Writing

Keep organized notes of all of the terms and agreements of the sale. This can prevent misunderstandings between parties and makes things much easier for the title company.

Hire A Home Inspector And Appraiser

You should always order a home inspection prior to a home sale, even if you plan to sell your home to a family member. A certified home inspector will take a look at your home and identify health, safety or major mechanical issues.

Home inspections benefit both the home buyer and seller because it protects the buyer from ending up with major issues with the roof, plumbing, electrical systems or other issues. Set aside any feelings and get the inspection anyway.

The buyer’s lender will require an appraisal to make sure the home is worth more than the loan amount. The appraisal might come in high or low, particularly if you forgo a REALTOR®, which happens often with sales to relatives.

To sum up, it's always beneficial to complete both a home inspection and an appraisal.

Double Check Your Compliance With Tax Laws

The IRS may accuse the parties of trying to avoid the capital gains tax if you don’t follow the law. No matter what, you want to follow IRS gifting laws if you sell your home for less than its fair market value. Your tax attorney can help you understand the relevant information regarding these gift laws.

Again, it’s best to hire a tax attorney so both you and your buyer ensure that you follow all tax laws.

Keep Emotions At Bay

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

One common mistake sellers make involves treating the sale more casually than they would normally. They may ask for too little, then end up strapped for cash later. Asking a family member for an amount far below market value may lead to regret in the future.

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

  • Settling on a fair price
  • Following all the appropriate steps
  • Obeying the tax laws
  • Hiring the professional assistance you need

Is It Worth It To Sell A House To A Family Member?

There are a lot of potential benefits to buying a home from a friend or relative, but mixing home sales and family can be a sticky business. The same goes for selling a house to a family member.

If you sell your home to someone you trust, it might make all the difference.

The drawbacks can include the following:

  • Not making as much as you would have if you put the home on the market
  • Skipping steps in the process because “it's family”
  • Not understanding your home's fair market value
  • Fumbling with gift tax laws (including raising red flags with the IRS) and more

Prior to making the decision to sell to a family member, both parties should weigh the pros and cons before moving forward with the home sale.

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

Understanding why the government is suspicious of non-arm’s length transactions can help you avoid future financial calamity by following all relevant rules. More importantly, you’ll have to decide – if the transaction is between a parent and child – if it’s worth the potential loss of the step-up in basis (if the current value is above the original purchase price) upon the parent’s death. Make sure you consult a tax professional before completing the transaction.

Ready to move forward with your purchase of a family member’s home? Apply online now to get the financing you need.

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Miranda Crace

The Quicken Loans blog is here to bring you all you need to know about buying, selling and making the most of your home. Whether you’re thinking about becoming a homeowner, selling your current home or looking to keep your place in tip-top shape, our writers and freelancers bring their experience and expertise to meet you right where you are.