Selling a house to a family member involves a different set of considerations compared to a typical open market sale. When family members conduct real estate transactions, the Internal Revenue Service (IRS) and other authorities often pay closer attention to ensure the sale price reflects fair market value.
Learn how to sell a house to a family member step by step, including determining the home’s fair market value, understanding tax rules like capital gains tax and gift tax, and preparing all legal documentation needed for a compliant and smooth transaction.
Understanding Non-Arm’s Length Transactions
Arm’s Length vs. Non-Arm’s Length Transactions
Arm’s Length Transaction
A sale between individuals or entities who don’t have a pre-existing relationship. Both buyer and seller are acting independently without influence from each other. Standard Transaction
Each party acts in their own self-interest. The seller tries to get the highest price, while the buyer aims for the lowest price, creating a natural balance.
These transactions typically reflect true market value because they’re based on competitive negotiation rather than personal relationships. Most real estate sales fall into this category.
Non-Arm’s Length Transaction
A controlled transaction between related parties such as family members (parents/children, siblings), business partners, or entities with shared ownership. Related-Party Sale
Can raise concerns about undervaluation or gift tax liability if the purchase price is below fair market value. Tax authorities often scrutinize these transactions closely.
May require additional documentation and formal appraisals to prove fair market value was paid, especially for mortgage approval or tax purposes.
Because selling property to family members is deemed a non-arm’s length transaction, authorities scrutinize whether the seller and gift giver might be trying to circumvent taxes or create an artificially low (or high) selling price.
Why the Government Scrutinizes Family Transactions
Potential Tax Avoidance or Fraud
When selling a house to a family member below its fair market value, the IRS considers the difference between the purchase price and the home’s fair market value as a gift. For example, if your home is worth $300,000 and you sell it for $250,000, the IRS would consider the $50,000 difference as a gift amount, which may trigger gift tax implications if it exceeds annual exclusion limits.
Ensuring Compliance with Tax Laws
Tax laws require the seller to properly report any sale significantly below current market value. For 2024, the annual gift tax exclusion is $18,000 per recipient and for 2025, it increases to $19,000. If the gift amount exceeds these thresholds, the seller must file a gift tax return (Form 709) by April 15 of the following calendar year. Failure to accurately report such transactions could result in an accuracy-related penalty of 20% of the underpaid tax amount, as the IRS may consider this a substantial understatement of income tax or negligence in following tax regulations.
Preparing for the Sale
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Obtain a Professional Appraisal
- Use a certified home inspector or appraiser to assess the property’s fair market or current market value.
- This neutral third-party evaluation helps both buyer and seller stay on the same page.
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Compare Similar Properties
- Look at comparable real estate sales in the neighborhood.
- Gather information on similar homes’ purchase price and selling price to understand local market trends.
- Align with the Appraised Value: Matching or staying close to the home’s fair market value is often the simplest way to avoid disputes with the IRS.
- Gift Tax Exemption: If you decide to discount the home’s purchase price below its established value, be mindful of the annual exclusion limit for gifts. For amounts above this limit, you may need to file a gift tax return.
- Consult Professionals: A real estate attorney or tax professional can help clarify gift tax rules and confirm whether you need to pay gift taxes on any portion of the transaction.
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Real Estate Agent
- Although you’re selling property within the family, a real estate agent can provide objective insights on the home’s fair market value, typical home closing process, and standard contract details.
- Agents often have access to multiple listing services (MLS) and can help with paperwork to ensure a smooth home selling process.
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Real Estate Attorney
- A real estate attorney can review contracts, draft addendums, and confirm compliance with state-specific real estate laws.
- They’ll help avoid misunderstandings and ensure the sale aligns with legal standards.
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Tax Professional or Financial Advisor
- Consult a tax professional to clarify potential tax implications of the sale.
- They can advise on strategies to reduce capital gains tax, plan for a gift tax return if necessary, and ensure the transaction adheres to unified federal gift and estate tax exemption rules.
Tax Implications
Capital Gains Tax Basics
- Capital Gains: If the house you’re selling has increased in value since you first bought it, you might owe capital gains tax on the profit. For 2025, long-term capital gains (assets held over one year) are taxed at 0%, 15%, or 20%, depending on your income bracket.
- Primary Residence Exclusion: If the house was your primary residence for at least 2 out of the 5 years before sale, you may qualify for the Section 121 exclusion, allowing you to exclude up to $250,000 ($500,000 for married couples filing jointly) from capital gains tax in 2025.
- Pay Capital Gains Taxes: If the buyer is a family member, this does not necessarily eliminate or reduce your obligations. You must still report gains accurately on your taxes, even in related-party transactions, and the IRS may scrutinize these sales more closely.
Gift Tax Overview
- Gift Tax Exclusion
- The IRS allows an annual exclusion limit per recipient. If the discount on your home to a family member exceeds this limit, it’s considered a taxable gift.
- “Gift of Equity” transactions happen when a seller offers a house to a family member at a significantly reduced purchase price. The difference between market value and the actual selling price is considered part of the gift.
- Gift Tax Return Requirements
- If the fair sale price is well under market value and above the annual exclusion limit, you (the seller and gift giver) may need to file a gift tax return.
- Filing this return does not necessarily mean you’ll pay gift tax; it just helps the IRS keep track of your lifetime gift tax exemption.
Estate Tax Exemption Considerations
- Unified Federal Gift and Estate Tax: The U.S. tax system unifies gift tax and estate tax under a lifetime exemption amount.
- Implications of Large Gifts: Depending on how much of your lifetime exemption you’ve used, the portion of the home’s value you “gift” might reduce the amount you can bequeath without estate taxes in the future.
The Home-Selling Process to a Family Member
When selling a home to a family member, follow this step-by-step process to ensure a smooth and legally compliant transaction:
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1. Agree on Terms
- Discuss the purchase price, down payment (if any), and any existing mortgage details.
- Both parties should clarify if any rent-to-own or seller financing arrangement will be set up.
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2. Draft a Purchase Agreement
- Put the terms in writing. A purchase agreement is vital for preventing later disputes.
- Include all contingencies, such as inspection clauses or financing conditions.
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3. Secure Financing (If Needed)
- The buyer may pay cash, work with a lender, or arrange a family financing plan.
- In some cases, a title company or lender requires additional documentation to validate a non-arm’s length transaction.
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4. Open Escrow and Title
- An escrow or closing agent will handle funds and ensure conditions are met.
- A title company can confirm clear ownership and handle the property title transfer.
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5. Complete Necessary Inspections
- Even if you know the property well, an inspection can highlight any undiscovered issues.
- A home inspector’s report may also be required by the buyer’s lender for financing.
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6. Close on the Sale
- At closing, the deed is officially conveyed to the new owner, and the agreed-upon funds are disbursed.
- Each party should review all paperwork to confirm accuracy and legality.
Risks and Benefits of a Non-Arm’s Length Transaction
Key Risks
- Tax Complications: Selling a house below fair market could trigger potential tax implications, including a gift tax liability if the gap between the market value and purchase price is large.
- Scrutiny from the IRS: Non-arm’s length transactions are often subject to deeper review by the IRS for any sign of a controlled transaction intended to avoid capital gains tax or gift tax.
- Future Mortgage or Resale Challenges: If the buyer later decides to resell, a lower-than-market purchase price can affect future capital gain calculations.
Key Benefits
- Retaining Ownership in the Family: A home sale can keep a cherished property within your extended family circle.
- Flexibility in Financing: Private or seller-financed transactions can be easier to arrange between family members.
- Streamlined Process: You may skip marketing expenses and other fees associated with a traditional sale.
Alternative Option – Gifting a House
Full Gift vs. Partial Gift
Full Gifting
Transferring 100% of the home’s fair market value as a gift to a family member without receiving payment in return. Full Property Value
Full gifting demands attention to unified federal gift and estate tax limits, which determine how much you can gift over your lifetime before incurring gift taxes.
Requires filing a gift tax return (IRS Form 709) even if no tax is owed due to the lifetime exemption. A formal property appraisal is typically needed to establish fair market value.
Partial Gift (“Gift of Equity”)
When you sell the property under its fair market value, the difference between the selling price and the appraised value counts as a gift. Partial Property Value
Be mindful of gift tax rules regarding annual exclusion limits. You can gift up to a certain amount per recipient each year without affecting your lifetime gift tax exemption.
A gift of equity can sometimes be used as a down payment for the buyer’s mortgage, potentially eliminating the need for additional cash at closing.
Why Hire Professionals for Gifting
- Tax Attorney: They can advise whether a gift tax return is required and explain any capital gains tax implications the recipient might face if they resell.
- Financial Advisor: For large gift transactions, a financial advisor can help you structure the deal to optimize tax benefits and avoid a costly mistake.
Key Takeaways: Ensuring a Smooth and Tax-Compliant Family Home Transfer
Learning how to sell a house to a family member requires special attention to fair market value, gift tax rules, and proper documentation. Because non-arm’s length transactions can attract closer scrutiny from the IRS, it’s wise to involve a real estate attorney, real estate agent, or tax professional. Start by getting an appraisal to determine a fair sale price, draft a thorough purchase agreement, and follow through with state-specific real estate laws. By doing so, you’ll minimize any potential tax implications and streamline the entire home selling process.
For more helpful insights about selling property quickly and efficiently, explore iBuyhomes.com. Whether you’re searching for fast cash offers or guidance on traditional sales, working with experienced professionals ensures a smooth and compliant transaction.
Yes, if you profit from the sale above your cost basis and don’t qualify for any exemptions. Non-arm’s length transactions do not automatically remove your obligation to pay capital gains taxes.
The difference between the home’s fair market value and the selling price may be considered a gift. If it exceeds the annual exclusion limit, a gift tax return may be necessary. Consult a tax professional for clarity.
While not always legally mandatory, hiring a real estate lawyer is highly recommended. They ensure all documents comply with local real estate laws and help avoid misunderstandings.
A real estate agent can provide a reliable estimate of fair market value, manage documentation, and keep transactions on track. Their expertise can be invaluable even when selling to family members.
Closing costs often include appraisal fees, title insurance, transfer taxes, and filing fees. You can negotiate who pays these costs, but keep it in writing within the purchase agreement.
