Yes, parents can sell a house below market value to their child, and it happens routinely, but the IRS treats the discount as a gift and that changes the tax picture for both sides. The gap between the appraised value and the price you pay is called a gift of equity, and it can trigger gift-tax reporting for your parents, reshape your future capital gains bill, and, if either parent may need long-term care, create a serious Medicaid problem. Most families won’t owe gift tax, but the paperwork and planning still matter.
The Two Transactions Hiding Inside One Sale
When you buy your parents’ home for less than its appraised fair market value, the IRS sees two things happening at once: a sale at whatever price you actually pay, and a gift equal to the discount. That discount is the gift of equity.
If the home appraises at $500,000 and your parents sell it to you for $350,000, the sale is $350,000 and the gift of equity is $150,000. Each piece carries its own consequences. Your parents deal with the gift side and the capital-gains side. You deal with the basis you carry into the future.
What Your Parents Owe and Report
Gift Tax Reporting
Your parents are the donors, so any gift-tax filing falls on them. In 2026, each person can give up to $19,000 per recipient without reporting anything. Two parents who both own the home can combine exclusions and give you up to $38,000 before paperwork kicks in.1Internal Revenue Service. Frequently Asked Questions on Gift Taxes
A gift of equity larger than that requires them to file IRS Form 709 for the year of the sale.2Internal Revenue Service. Instructions for Form 709 (2025) Filing rarely means owing. The amount above the annual exclusion simply reduces their lifetime exemption, which sits at $15 million per person for 2026 after the One, Big, Beautiful Bill raised it from $13.99 million.3Internal Revenue Service. What’s New – Estate and Gift Tax A married couple shares up to $30 million combined. For most families, Form 709 is a tracking exercise.
Capital Gains on the Sale Portion
Your parents also made a sale, and the IRS can tax any gain on that piece just as it would an arm’s-length transaction. The gain equals the sale price minus their adjusted basis, which is roughly what they paid plus the cost of major improvements.
If your parents lived in the home as their primary residence for at least two of the last five years, they can exclude up to $250,000 of gain, or $500,000 if they file jointly.4Office of the Law Revision Counsel. 26 U.S. Code 121 – Exclusion of Gain From Sale of Principal Residence The related-party restrictions in Section 121 only block this exclusion for sales of remainder interests, not for a standard sale of the full property to a child. In most below-market family sales, the gain on the sale portion is partially or fully sheltered.
Losses Are Not Deductible
If the sale price is lower than your parents’ adjusted basis, they cannot deduct the resulting loss. Federal tax law flatly prohibits deducting losses on sales between parents and children, even when the discounted price is genuinely fair given the home’s condition.5Office of the Law Revision Counsel. 26 U.S. Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers The disallowed loss isn’t entirely wasted. If you later sell at a gain, you only pay tax on the portion of your gain that exceeds the loss your parents couldn’t deduct.
Your Cost Basis as the Buyer
This is the number the IRS uses to calculate your capital gain when you eventually sell, and it’s where below-market sales can quietly cost you. Your basis is the greater of the price you paid or your parents’ adjusted basis at the time of the transfer.6eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale
Return to the $500,000 house sold to you for $350,000. If your parents’ adjusted basis was $100,000, your basis is $350,000 because that price exceeds their basis. Sell later for $600,000 and your taxable gain is $250,000. That gain might qualify for the primary-residence exclusion if you’ve lived there long enough, but if the home becomes a rental or you sell within two years, the full gain is taxable.
If your parents’ basis were higher than the price you paid, say $400,000 against your $350,000 purchase, your basis would be $400,000. You’d carry forward their basis, and their holding period would tack onto yours for purposes of qualifying for long-term capital gains rates.7Office of the Law Revision Counsel. 26 U.S. Code 1223 – Holding Period of Property
One more wrinkle. If you later sell at a loss, the basis for calculating that loss cannot exceed the home’s fair market value on the date your parents transferred it to you.6eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale The rule keeps you from inflating a loss using a basis higher than the property was actually worth.
Why Inheriting Can Beat Buying at a Discount
If you inherit the same home after your parents pass, your basis resets to the market value on the date of death. That stepped-up basis can wipe out decades of accumulated gain in a single stroke.8Office of the Law Revision Counsel. 26 U.S.C. 1015 – Basis of Property Acquired by Gifts and Transfers in Trust A below-market sale does not get this treatment. When the home has appreciated substantially and your parents are elderly, the capital-gains math may actually favor waiting to inherit. That’s a conversation worth having with a tax advisor before closing.
Medicaid Look-Back: The Biggest Hidden Risk
If either parent might need Medicaid-funded long-term care within the next several years, a below-market sale creates a real eligibility problem. Federal law imposes a 60-month look-back: when someone applies for Medicaid nursing-home coverage, the agency reviews every asset transfer made in the prior five years and flags anything transferred for less than fair market value.9Office of the Law Revision Counsel. 42 U.S.C. 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets
The gift-of-equity portion is exactly the kind of transfer Medicaid targets. It doesn’t matter that your parents received some payment. The discount is treated as a disqualifying transfer. The penalty is a period of Medicaid ineligibility calculated by dividing the uncompensated value by the average monthly cost of private nursing-home care in the state where your parent applies.9Office of the Law Revision Counsel. 42 U.S.C. 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets
A $150,000 gift of equity in a state where private nursing-home care averages $10,000 per month produces a 15-month penalty. During those months, your parent pays the full cost of care out of pocket. For parents in their 70s or older, or anyone with health conditions that could lead to long-term care, this risk deserves careful evaluation before the sale closes.
Financing the Purchase with a Gift of Equity
Mortgage lenders handle these transactions routinely. Both conventional loans backed by Fannie Mae and government-insured FHA loans allow the gift of equity to count toward your down payment and closing costs.10Fannie Mae. B3-4.3-05, Gifts of Equity If the equity gift is large enough, you may not need to bring cash to closing beyond what the lender requires for reserves.
Your parents will need to sign a gift letter stating the dollar amount of the equity gift, confirming that no repayment is expected, and identifying their names, address, and relationship to you.11Fannie Mae. B3-4.3-04, Personal Gifts Lenders take this seriously because a gift that secretly requires repayment is really a second loan, which changes your debt-to-income ratio and your eligibility.
An independent appraisal is also required. The lender needs to verify fair market value to confirm the size of the equity gift and check that the loan-to-value ratio supports the mortgage. The equity gift shows up on the settlement statement at closing.10Fannie Mae. B3-4.3-05, Gifts of Equity On an FHA-financed purchase, only family members can provide a gift of equity.12U.S. Department of Housing and Urban Development. FHA Single Family Housing Policy Handbook 4000.1 Conventional loans also allow gifts of equity for second homes, not only primary residences.
Property Taxes and Closing Costs
A below-market sale is still a sale to your county assessor. Many jurisdictions reassess property taxes when a home changes hands, and reassessment is based on current market value, not the discounted price you paid. If your parents bought decades ago and local values have climbed, your annual tax bill can jump sharply. A handful of states offer exemptions or reduced reassessment for parent-to-child transfers, but the rules and filing deadlines vary. Check with your county assessor before closing so the new bill doesn’t catch you off guard.
Beyond property taxes, expect the standard closing costs of any real estate transaction: the lender’s appraisal fee, title search, potential title insurance, and recording fees for the new deed. Some states and localities also charge real estate transfer taxes calculated as a percentage of the sale price or assessed value. Even at a discounted price, these costs add up. Get estimates early so both sides know what to budget.