How To Sell A House To A Family Member
Selling a house to a family member can be more complicated than you think. Even though you might try to do it without any professional assistance to save money, there are issues you could face—such as potential tax implications or family difficulties—that you would otherwise avoid through the traditional home-buying process with a professional.
Here are some things to keep in mind when selling your home to a family member.
Why Is a Family Home Sale Different?
When you sell a home to someone you don’t know, it is known as an arm’s length transaction, which means the two parties came to the purchase agreement free and independent of each other. The expectation is that each party will negotiate for the most advantageous price, and, in most cases, an appraiser working on behalf of the lender will confirm that.
However, when you’re related to the person in the transaction, the IRS does not consider this an arm’s length transaction, and instead refers to it as a controlled transaction. The IRS will examine the sales price to see if it reflects the fair market value or if the seller is giving the buyer a gift of a much lower sale price.
How Is a Gift Price Defined?
The fair market value of a home, as defined by the IRS, is “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.”
If you decide to sell for a price that’s lower than fair market value, you might have to report to the IRS that you provided a gift to the buyer. For the 2020 and 2021 tax years, the annual gift exclusions are $15,000 for individuals and $30,000 for married couples, which is the maximum amount you can discount the sale without reporting it as a gift to the IRS.
You can learn the fair market value by consulting with a realtor and/or an appraiser, along with a thorough home inspection.
Even if you provide a gift in the home sale, you likely won’t have to pay taxes—there is no need for a gift tax payment unless you have given away more than $11.58 million to this person in their lifetime, as of 2020. You’ll still need to file a return if you go over the gift limit for the year for the IRS to keep track of how much you’ve provided in gifts over a lifetime.
Who Pays the Gift Tax?
The buyer would not have to pay tax on the gift; the donor is generally responsible for paying the gift tax. The main tax risk is if you give the entire home to the family member—then your tax basis for the home is inherited by the recipient. That means if your tax basis was $50,000 for the home when you bought it, the taxable gain for the family member could be $250,000 if he/she sells it for $300,000 years later.
5 Steps for Selling Your House to a Family Member
1. Agree on the Process
Before you decide on a price for the home, you need to agree on the process. This can reduce confusion and conflict down the road because you’ll identify whether you want to bring in professionals (such as a Realtor or appraiser), discuss how the buyer will finance the purchase and set a timetable. You also need to establish who the decision-maker is for both the buyer and seller so there is no confusion if other parties get involved and try to change the agreement.
2. Hire Professionals
Even if you have a good relationship with your family member, a major transaction like a home purchase can cause hiccups if there are disagreements over contracts and fees. You might think you don’t need a real estate agent, but you’ll still need someone to ensure that the paperwork—such as the purchase contract—is drawn up correctly, all state-required property disclosures are made and the home sells for fair market value.
It’s possible an agent will work for a flat fee or deeply discounted commission for both parties. A real estate attorney could also draw up and review key documents; one lawyer might be OK, or each party might need representation. Also, if the transaction doesn’t involve a lender, you should at least get an appraisal (which is usually required by a lender) to make sure the price is fair.
3. Evaluate the Home
This step depends on how you’re handling the transaction. If you plan to hire professionals, the agent will provide a comparative market analysis, which the appraisal confirms. You’ll also need a professional home inspection, which the buyer typically pays for.
4. Agree on a Price
You could come to a price agreement based on the agent’s estimate and/or the appraisal, or wait until after the inspection. Regardless, you’ll want to have a purchase contract that includes relevant contingencies, such as voiding the contract if the buyer can’t secure a mortgage by a specific date.
5. Proceed to Closing
If the purchase involves a lender, you’ll have a traditional closing that includes a title company and might require the presence of a real estate lawyer. Some might choose a seller-financed arrangement, in which you draw up a promissory note that includes the loan terms and record it with a local government. You’ll likely want to work with a lawyer to ensure the note is drawn up correctly and the terms are acceptable.
Tips for Buying a House from Family
If you’re in fact the one buying a home from a family member, it’s vital to protect your own interests, especially if there is a lot of pressure from the seller to move the process along without any professional input.
As the buyer, you should:
- Get a professional price estimate. Most sellers believe their home is worth more than it really is, and this can especially be the case if you’re trying to buy a long-time family home that holds priceless memories. Getting an impartial third party to examine comparable homes that have sold in the area as well as the home’s current condition will assure you that you’re getting the best price.
- Secure legal representation. Buying a home is a complex process that involves many regulations and potential pitfalls, so you’ll want to make sure you have a lawyer on your side, even if it’s one both you and the seller agree to hire to oversee the transaction. An attorney can ensure you have all the proper contingencies in the purchase contract, review the title for liens and push to get the proper property disclosures.
- Hire an inspector. For a few hundred dollars or more, you can buy a lot of peace of mind by hiring your own home inspector. The inspector’s report will give you an unvarnished look at the condition of the home and shine a spotlight on major issues that might affect the sale price.
- Make sure it’s the right home for you. Buying a family member’s home might seem like a generous act if the family member needs to move for financial or health reasons and you can help them out. But if it’s not an ideal home or community for you, it ultimately won’t be worth it.
Home transactions involving family members can be an affordable and easy process, but it’s best to prepare for complications. That’s why you’ll want to hire the right professionals to help you meet all local, state and federal regulations and ensure both sides are getting a fair deal.