Selling your home to a family member opens up a whole can of worms that doesn’t apply to a traditional exchange of real estate between strangers.
Not only are you risking your family relationships by creating a financial arrangement with a loved one, but you’ll be attracting the attention of the IRS who’ll scrutinize the sale for potential tax evasion.
However, keeping your house in the family can be done successfully if you follow these tips to help you avoid the red flags that attract scrutiny.
Tip 1: Enlist professional legal help to navigate the process
When you’re selling to someone that you know, love, and trust, it can be tempting to handle the whole home sale arrangement without any professional assistance.
However, that’d be a mistake: third-party experts provide a buffer between you and your relative to prevent the appearance of impropriety when the IRS examines the transaction, and more.
“Number one, these experts can help you determine the appropriate sale price for the home based on its fair market value. And secondly, they can help protect your relationship with the relative you’re selling to. You don’t want to create a permanent rift between family members because of a real estate transaction. Nothing is worth that.”
OK, so maybe you agree that enlisting the help of one expert is a good idea, but do you really need the expense of both an attorney and a real estate agent if you’re just selling to family?
It may not be necessary to hire an agent (who’ll likely expect a 6% commission on the home sale), but it’s definitely the smart choice.
“Sometimes homeowners selling to relatives just go straight to an attorney to have the paperwork drawn up, but drawing up the contract is the easy part,” explains Beams.
“An attorney doesn’t necessarily understand the whole home sale process. An agent will help you get through the inspections, appraisals, and the loan process too, which can be challenging.”
Selling property to a relative for less than it’s worth changes your tax liability (more on that in a minute), but the relative you’re selling to may not understand the red flags raised by giving family too good a deal on a home sale.
It takes expert guidance from an experienced agent to sidestep permanent family rifts caused by these misunderstandings. As the same of an attorney, and they’ll charge you by the hour.
Plus, there is no law that states you must pay a 6% commission to a real estate agent.
Since you’re bringing in the buyer, you may be able to find an agent willing to accept a lower commission percentage. After all, it will be a relatively quick sale without any of the listing, marketing, or showing hassle.
Tip 2: If you don’t plan to gift the house, then stay true to your home’s fair market value
Selling your house for less than it’s worth isn’t unheard of in the real estate world. If there’s plenty of homes for sale and only a handful of buyers house-hunting, it’s not uncommon for homeowners to sell at a reduced price or make a number of high-value concessions just to get the home sold.
If this happens when both the buyer and the seller are strangers with no relationship between them, the IRS considers this an arm’s length transaction.
So, they’re willing to write it off as a bad real estate transaction for the homeowner—meaning the buyer won’t need to pay special taxes on the good deal they got.
But selling to a family member is regarded as a non-arm’s length transaction.
“You have to be super careful giving a good deal on your home to a relative, because if it’s too good a deal, it can raise red flags with the IRS,” explains Beams.
However, this doesn’t mean that you need to sell your home to your loved one at its full market value. You can give them a good deal as long as you don’t go too low.
So, how low can you go?
The actual percentage will vary based on the specifics of your situation. However, setting the price at an amount above 75% of the home’s fair market value is a good ballpark percentage to start at.
If you give your relative a discount of 25% or more off of its fair market value (FMV), you could end up in the crosshairs of the IRS.
Tip 3: Check your compliance to federal tax laws if you gift the house
When the home sale price between family members is lower than the property’s FMV, both the buyer and the seller need to be careful to comply with federal tax laws.
“You should always try to sell at a price that’s pretty close to the home’s actual fair market value, because there are tax implications if you sell your home to a relative at less than fair market value,” explains Beams.
“Since you’re essentially gifting your relative a portion of the home’s value, taxes would need to be paid on that gift according to the federal gift tax law. Plus, the IRS might think that you’re trying to avoid paying capital gains taxes or something like that.”
For example, if you’re selling your primary residence at a profit that’s less than $250,000 if you’re single (or $500,000 if you’re married), it’s exempt from capital gains tax. But if you’re selling it for more, then you’ll need to pay a capital gains tax on the excess proceeds.
So, if your price reduction reduces your proceeds so that they fall below that exclusion threshold, the IRS will red flag the transaction as an attempt to sidestep the capital gains tax.
The second area to concentrate on is complying with federal gift tax laws.
When you sell your home for significantly less than its fair market value, the IRS considers the value of that reduction as a taxable gift to your relative—even if no actual cash changes hands.
There are a number of ways to structure the home sale that reduce your chances of paying excessive taxes on the transaction—for more guidance, use HomeLight’s comprehensive guide for gifting your house to your child or another relative.
Tip 4: Get your home’s value from a legit source
Since your home’s fair market value is central to setting up an intra-family home sale that doesn’t raise IRS red flags, it’s essential that you get its FMV from a legitimate source.
Simply looking at what nearby neighbors have recently sold for isn’t nearly good enough. Even a comparative market analysis (CMA) from a qualified real estate agent is probably not the best resource if you’re looking to give your relative a good deal on the price.
There’s a difference between what your house is worth and what you can get for it were you to sell it via a traditional home sale. A CMA is designed to pinpoint the highest price you can list your home at, were you planning to sell to a stranger.
That’s not the amount you want to set as the fair market value in this scenario.
“The easiest way to avoid tax issues is to get an appraisal, then sell the home at a price that’s close to that appraisal so you can’t be accused of trying to circumvent the tax laws,” says Beams.
If your family member is going through a mortgage lender to purchase the home, then their bank will likely require an appraisal than can be used to determine the FMV.
“There could be some issues getting financing when you’re buying from a lender, because your mortgage company may say that it’s not an arm’s length transaction,” advises Beams. “So, the mortgage company is going to order an appraisal and look really hard at that whole transaction.”
While the appraiser will pull the same comps that an agent would for the CMA, the appraiser’s aim is to find a market-appropriate home value so the bank doesn’t lend more than the home is worth.
Tip 5: Set emotions aside when making decisions (and don’t skip steps!)
When the buyer is a relative, one mistake sellers make is treating the sale casually because “it’s family.” Letting the process become too informal just sets you up to make financial decisions based on emotion rather than logic.
“Selling to a relative can get pretty testy. I’m working with clients right now where one woman is the legal owner of grandma’s house, so she has set the asking price,” explains Beams.
“But her sister thinks the house is worth significantly less, because it’s her son who wants to buy the property. So you have to make sure all the parties of the transaction are on the same page.”
And it’s not just setting the fair market value and sale price where you’ll run into trouble. When you fail to approach the process as the serious business arrangement it is, you’re more likely to skip important steps that’ll cost you in the long run.
“You should never skip steps of the home sale process when you’re selling to a relative or it might create animosity between family members in the future,” advises Beams.
“For example, if you skip the home inspection and then later find a termite problem or roof issue, that’s going to cause some resentment. That’s why it’s important to have an inspection and appraisal, get the title work done, and hire an experienced agent to help you through it all.”
For more advice, HomeLight has a handy list of 10 Do’s and Don’ts for Selling a House to a Friend (which applies to family members just the same.)
Is selling a house to family a good idea?
Even when you’re opting for a traditional sale, selling a house is a complex process.
When your buyer is a relative, you’re adding extra red tape. However, if you settle on a fair price, follow all the appropriate steps, obey all the tax laws, and hire the professional assistance you need, you can successfully sell your home to a family member without paying more taxes than required by law.
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