Selling a House to a Family Member: Gift of Equity, Arm's Length and What the Lender Wants

Selling a house to a relative is common, legal and full of small traps, nearly all of which come from one fact: the price is not being set by a market. Lenders, the IRS and, later, other relatives all look at a family sale more carefully than an ordinary one. Get the structure right and it is a clean transaction. This is general information, not legal or tax advice; a family sale is exactly the kind of transaction to run past a CPA and a real estate attorney first.

Arm's length, and why it matters

An arm's length sale is one between parties who are independent and each acting in their own interest. A sale to your daughter is not, and everybody involved will treat it accordingly. That is not a bar to doing it. It is a reason to document the value of the house independently, because nobody will take your word for it.

Get an appraisal, even if you think you know the value

A licensed appraisal is the document that protects every part of a family sale. It establishes fair market value for the lender, for the gift calculation, for the buyer's future basis, and for any sibling who later suspects one child got the house cheap. It costs a few hundred dollars and it is not optional in practice.

Selling below market: the gift of equity

If you sell for less than the appraised value, the difference is a gift. That is fine, and it is done every day, but it has consequences:

• Gift tax reporting. A gift above the annual exclusion amount has to be reported on a gift tax return. Reporting is not the same as paying; for most families the gift simply reduces a lifetime exemption that is far larger than the house. The return still has to be filed.
• The buyer's basis. A relative who buys at a discount takes a lower basis, which means a larger taxable gain when they eventually sell. A large discount today can be a large tax bill for them in twenty years. Compare this with inheritance, where the basis is stepped up; see selling an inherited house.
• Your own gain. Your capital gain is calculated on the actual sale price, not the appraised value, so a discount reduces your gain. If you have lived in the house, the home sale exclusion usually covers it anyway.

What the lender requires

If the relative is borrowing to buy, their lender will flag the sale as non-arm's-length and apply extra rules. Typically the lender wants the appraisal, a gift of equity letter signed by you stating that no repayment is expected, evidence that you own the house outright or that the sale pays off your mortgage, and sometimes confirmation that you are not in default or foreclosure. Many lenders will let a gift of equity count toward the buyer's down payment, which is often the whole point of the structure. Ask the lender for its checklist before agreeing a price with the relative.

Use a real contract and a real closing

Do not hand over a deed at the kitchen table. Use a written purchase agreement, a title search, title insurance for the buyer, and a closing through a title company or attorney, exactly as you would with a stranger. A family sale without a title search can leave the relative holding a house with an old lien on it, and a deed transferred without a recorded sale creates problems for the next sale, for insurance and for property tax reassessment.

Property tax reassessment

In many places a sale triggers a reassessment to current value, and a family transfer is still a sale. Some states have exclusions for transfers between parents and children, with forms that must be filed on time. Check before closing, because a missed filing can raise the relative's tax bill permanently.

Keep it fair to the rest of the family

The sale that causes lasting damage is the one where a parent sells to one child below market and the other children find out later. If the discount is intended as an advance on inheritance, say so in writing, ideally in the will or trust. If it is not, say that. The appraisal makes the size of the gift a fact rather than an argument.

Renting it back, or staying on

Parents often sell to a child and stay in the house. That is a tenancy, and it should have a written lease and a rent, however nominal, because the arrangement affects the child's mortgage, insurance and taxes. It also affects benefit eligibility in some cases, which is a question for an elder law attorney rather than a guide.

When a family sale is the wrong tool

If the real goal is to get money out of the house quickly, or the relative cannot actually afford it and would be relying on you not to enforce the terms, a family sale is a slow way to create a family problem. A cash sale to a third party and a cash gift to the relative afterwards is often simpler, cleaner and better for everyone's taxes.