Looking to sell your home to a family member off-market? Well, while you’re reading this article, you can also sign up with Flyhomes . A expert real estate agent from Flyhomes will help you navigate this idea.
When you’re selling your home to a family member, you’re at peace. This is because the home you’ve created countless memories in, will remain within the family itself. And that’s awesome!
But there are certain things you need to know about, before moving forward with ‘transfer of ownership’ of the home.
- You might not make a profit on the offer as you may have hoped for (if the home was listed on the open market)
- Misreporting, or failing to report this transaction can raise red flags with the IRS. This will create a tax liability for either party in the future.
- The relationship between the buyer and seller could become strained, should anything go array.
How is selling your home member different?
The government and third-party service providers treat real estate transactions differently depending on the relationship between the buyers and sellers.
An arm’s length transaction is one where someone sells a home to someone with no personal ties.Both the buyer and seller enter into a purchase agreement, free and independent of each other (with each party looking to acquire the best deal for themselves).In this scenario, the expectation is that both the buyer and seller will negotiate to secure the best possible deal for themselves. An appraisal will determine the home’s market value – which will guide the listing and the sale price.
But, if the home is being sold to someone you already know off the open market, it is known as a non-arm’s length transaction (controlled transaction). The parties involved in this transaction will agree on a purchase price which is independent of typical market conditions.
What happens if you sell the home for a price below the market value?
Here, the IRS considers the transaction as a taxable gift. This must be reported on the disclosure forms during the sale.
Let’s make it easier to understand with an example. If you’re selling your home to your niece for a flat fee of $1, you will require additional documentation which will be required to explain why you sold the home at that particular price.
Although non-arm’s-length transactions are legal, they are at a higher risk of being fraudulent which is why the IRS pays close attention to controlled transactions.
What is the gift tax?
If you sell your home for less than you could on the open market, the IRS will lose out on the potential revenue from the full-price sale. They make up that difference by charging a gift tax. The gift tax also ensures that people don’t commit tax fraud by giving away gifts or sums of money to avoid paying income taxes.
As of 2023, the annual exclusion limit for tax-exempt gifts is $17,000 per recipient. This means you can give up to $17,000 to any individual in a calendar year without having to pay gift tax or file a gift tax return.
But there are also lifetime tax-exempt gift amount limits you should be aware of for estate planning.
Does selling my home to a family member affect my estate?
You can pass $12.06 million of your estate on to your family tax-free. If the total value of your estate plus the amount you’ve given away exceeds $12.06 million, the IRS will tax your estate on the amount above that lifetime limit.
For example, let’s say you sell your home to your daughter for $1, but the home is worth $1 million. You’ve gifted your daughter $1 million. If you were to die with an estate worth $12.06 million, in this example your lifetime gifts would equal $12.06 million plus the $1 million you gave away as part of the house (a total of $13.06 million). You would have passed your tax-exempt limit by $1 million and be taxed according to the federal and state tax rates.
Another way to think about it is by deducting the gift amount from your estate. Suppose you have $12.06 million in an estate and give a family member $1 million in equity by selling that house for $1. In that case, you now have $11.06 million left of tax-free estate to leave behind.
How to manage taxes when selling to a family member?
There are three concepts every seller should understand before selling a house to a family member.
- Equity
Selling your home for less than fair market value the IRS views the equity in the house as the gift. It will not view the house in itself.
Rather than gifting someone money, you’re giving them a discount on the home’s value. It is considered as a gift of equity when the price discount exceeds $16,000 in value.
Let’s use the same example as above (selling your home to your daughter). If you sell your $1 million home for one dollar, she will automatically have $999,999 of equity in the property. In other words, they paid a dollar for something they could sell for nearly $1 million.
- Gift Price
Their equity is the difference between how much your family member buys the home for. And how much they could sell it later. The IRS calculates the gift value on the buyer’s equity.
The best way to determine the home’s fair market value is to hire an appraiser and home inspector. Together, their evaluations will determine what the home is worth. You might already know how much you want to sell your home for. But knowing the actual value of the home is essential for planning your tax liability.
- Capital gains tax
When you sell your home, you’ll pay taxes on the money you make from the appreciated value. If they sell the home at a discount or give it to a family member outright, they may face a high tax bill when they sell it due to the profit they’ve made.
So, if your daughter buys your home for one dollar but then sells it a few years later for $1 million, she will have made $999,999 in taxable capital gains from the property.
Her tax rate for that capital gain will depend on a few factors:
- her marital status, income
- how long she owned the home
- if she gained income from it by renting it
- he home’s tax bracket.
Your daughter will have inherited the original tax bracket of the home from you when you gifted it to her. When she sells it, the home’s current value and any mill levy on the property determine the home’s new tax bracket.
If you’re unsure what this might mean for you, consult a knowledgeable real estate agent before moving forward with the sale.
Selling off-market to a friend or family member
By selling your home to a family member or friend, you’ll be helping them establish wealth and equity for the future. But make sure to do it strategically and legally. Consider the tax implications of a lower sales price.
Controlled transactions are real estate deals between family members. The IRS and the lenders treat controlled transactions differently.
If you’re selling the home below market value, the IRS may consider the transfer of property a gift, in which case a gift tax may apply. Discuss how a gift tax affects your estate planning and tax liability with an accountant or financial planner.
To ensure everything goes smoothly, get everything in writing, order a home inspection, hire an appraiser, and double-check compliance laws with a real estate lawyer or tax attorney.
Tips for selling to a family member
A well organized home sale is always a good thing to do. Here’s how you can avoid headaches later:
- Put everything in writing: Document all terms and agreements of the home sale. Everyone does business differently, even if you have an excellent relationship with the person you’re selling to. It’s a good idea to maintain copies of verified documents throughout the transaction and after the transaction has been completed.
- Hire professionals: You should hire at least one real estate agent and one real estate attorney. It will help make sure that the documentation is filed correctly on closing day. All state-required property disclosures and tax documents should be professionally handled and filed.
- Double check your compliance with tax laws: The IRS may think you’re trying to avoid paying capital gains tax or income tax (if you don’t properly disclose that you’re selling below market value). Your tax attorney will be able to guide you through this process. Make sure to consult with them before closing.
Whether you’re selling your home to a family member, or giving a gift – let Flyhomes help you with the nuances of the process. Flyhomes is always ready to guide you, and ensure a smooth transaction.
