A house is the biggest financial asset that most Americans own. According to the American Advisors Group (AAG), almost 75% of seniors say their home is both their biggest financial asset and also their biggest source of sentimental value. When it’s time to move into a smaller place or enter assisted living, it’s also time to sell the home that holds so many memories.
It makes sense that many Americans want to keep their homes within their families. The relatives can preserve their memories while gaining access to a home in a difficult market. However, selling a house to a family member isn’t always easy. It also comes with its own financial challenges and tax implications that traditional buyers and sellers don’t face.
Use this guide to learn everything you need to know about selling property to a child, sibling, cousin, or parent if you want to keep your biggest financial asset in the family.
- Selling to Family is Not an Arm’s-Length Transaction
- Things to Consider When Selling to Family
- Make Sure Your Relative Can Afford the Home
- Capital Gains Taxes and Other Considerations
- Be Clear About the Terms of the Sale
- Alternatives to Selling a House to a Family Member
- Consult a Real Estate Agent Before You Decide to Sell the House
Selling to Family is Not an Arm’s-Length Transaction
Most real estate sales are considered arm’s-length transactions, which means both parties are acting in their own interests. In a traditional sale, neither the buyer nor the seller has any relationship with each other and both parties usually hire Realtors to act on their behalf. The seller wants to get the maximum amount of money for their property while the buyer wants to pay the least amount. Both parties work in their own self-interest to reach an agreement on a fair purchase price.
Selling a house to a relative (whether you are selling to a child, sibling, or parent) is considered a non-arm’s length transaction. Both parties have a relationship with each other. A relative will often sell a house below the fair market value to ensure their other family member can afford it or because the transaction is a formality.
Mixing relationships and money is complicated. While you may have the best of intentions by selling your home to a family member below fair market value, your mortgage lender, appraisers, and even neighbors will have questions. This means the home sale might take longer than you expect.
Things to Consider When Selling to Family
The first thing to consider when selling a house to a family member is its current value. You need to answer two questions. These will help you set a purchase price that ensures your relative gets a fair deal.
What is the fair market value of the home?
To answer the first question, evaluate the current homes selling in your area. How much are houses of your size selling for in your city? This can give you a rough estimate of what your property is worth. You can also hire an appraiser to evaluate the home. A real estate agent can also provide an estimate based on their knowledge of fair market value.
How much equity does your family currently have in the house?
Once you have an idea of your home’s fair market value, look at your mortgage to understand how much you owe on the property. This can affect how much you sell the house for. If your house is completely paid off, you won’t have to worry about paying back a lender during this transaction.
Sample Home Pricing Strategy
Comparing home values and equity might bring you back to your middle school math class, but crunching numbers is important to ensure everyone gets a fair deal. Use this example situation to see why.
The median home price in 2000 was $165,300. By 2022, this price rose to $455,000. If you bought your home around market rate around the turn of the century then its value has potentially increased by $300,000. (This depends on where you live and the condition of the home.) However, you also still might have eight years left on your 30-year mortgage. When you sell the property, the bank will take out anything you owe from the profits.
Make Sure Your Relative Can Afford the Home
One significant factor to consider if you are selling a house to a family member is whether they can afford it. This includes the mortgage, taxes, home insurance, utilities, and general upkeep.
There may be some extra steps if your relative needs a mortgage to buy a home from you. Like any home purchase, you will start with the pre-approval process. Your relative will need to produce bank statements, pay stubs, tax documents, and other financial papers in order to show the lender they are in good financial standing. The lender will provide an estimate for the maximum home loan they are willing to provide. You can use a mortgage calculator to estimate your maximum loan amount beforehand.
Even though you are selling a house to a relative, you will still need to draft a purchase agreement. Your relative will need to conduct a title search, appraisal, and home inspection. This protects both parties in case your relative is not happy with the condition of the home. The buyer’s lender is also worried about fraudulent transactions, so following standard home purchase processes can assure them this sale is legitimate.
The loan might get denied if the lender decides your relative cannot afford the property. Even if they can handle the monthly loan payments, secondary costs like insurance and taxes might push them out of the loan qualification. If this is the case, you might need to lower the sale price of your house.
Capital Gains Taxes and Other Considerations
The next factor to consider when selling a house to a family member is whether you will owe taxes on the transaction. The IRS will not levy a capital gains tax on the profits of your home if it is your primary residence and you have lived there for more than two years. If you want to avoid capital gains taxes, you may want to keep living in the house as your primary residence until the two-year mark has passed.
The next thing to consider is whether you need to pay a gift tax, which also comes with its own set of exemptions. When you sell a house to a family member below market value, you are giving the gift of equity. This is the value of the home minus the sale price. For example, if you sell a house for $100,000 and it is worth $500,000 then your gift equity is $400,000. Essentially, you have given your relative that amount of the home’s value.
The next question is whether you have to pay gift taxes on the equity. In 2023, the IRS raised the estate-tax exclusion to $12.92 million. You can transfer this amount to your heirs over the course of your life without triggering an estate-tax bill from the government.
You still have to report the gift equity on your taxes. The government needs to know how much money, property, or equity you are giving your heirs. However, you might qualify for an estate tax exemption if the value falls below $13 million. Married couples can give up to $26 million in their lifetimes. After you cross over this threshold, estate tax rates start at 18% and extend up to 40% depending on the taxable amount owed.
If you are unsure if you have to pay capital gains taxes and other fees that come with selling a house to a family member, meet with a financial advisor or tax professional before you start this process.
Be Clear About the Terms of the Sale
There are legal agreements you need to address during a real estate transaction and there are also personal rules you should follow. These guidelines can ensure everyone is on the same page and positive familial relations are maintained.
For example, some parents sell their houses to their children but expect to keep living there. Your child should understand that one of the conditions of the sale is that they become your caregiver. Additionally, how does this home sale affect the inheritance of your children? Will your other kids receive more when you pass away because one child received gift equity? These same questions can apply regardless of your familial relationships. If you sell your house to a sibling, they won’t want your input in the redecorating process.
It is better to have a document agreed upon by everyone in the family when you sell a house for less than the fair market value to a relative. You don’t want to ruin a relationship by selling a house to a family member.
Alternatives to Selling a House to a Family Member
Selling your house to a relative below fair market value is a great way to keep a property within the family. You can preserve the memories of bright Christmas mornings and family gatherings in the summer by passing a house from one relative to the next. However, this isn’t always the best choice and you might be better off listing the house on the fair market.
Consider whether your relative actually wants to live in the house. They might not have the desire to move back to the area, especially if they live in a different city or state. You also might not be able to fairly divide your estate if one relative gets an entire house while your other heirs are left with smaller assets.
It might be time to say goodbye to this house so another family can start building their memories there. You can take the profits from the home sale and divide it up amongst your heirs. They can use these funds as down payments for their own homes to start growing their own wealth.
Consult a Real Estate Agent Before You Decide to Sell the House
Selling a house to a family member can be a smart financial decision for everyone involved. However, it can also create its own financial problems and disruptions within the family. If you are unsure whether this is the right step for you, or whether you are on the hook for capital gains taxes, talk to a real estate agent. An objective agent can walk you through the home-selling process. They will highlight what you need when selling a house below fair market value.
To find a real estate agent, turn to the agents at FastExpert. Our service helps your narrow down your agent search so you can find the best real estate agent for your needs. We have helped more than 500k clients since 2014, making FastExpert one of the leading sources to find Realtors on the web. Our service is completely free and you are not obligated to hire the agents we recommend. Find a Realtor near you and take the first steps to sell your house (to family members or otherwise) today.