Parents can legally sell a home to their child for less than it’s worth, and the IRS treats the difference between the property’s fair market value and the actual sale price as a gift. That single fact drives everything else about selling property to a child below market value: how the parents report the transaction, whether they owe capital gains tax, what the child’s cost basis becomes, and how lenders, Medicaid, and county assessors respond. For 2026, the lifetime gift and estate tax exemption is $15 million per person, so most families won’t owe gift tax, but the paperwork and downstream tax consequences still matter.1Internal Revenue Service. What’s New – Estate and Gift Tax
How the IRS Splits the Transaction
Federal tax law calls this a “bargain sale.” The transaction has two parts, and each part follows its own rules.2Office of the Law Revision Counsel. 26 USC 2512 – Valuation of Gifts
Take a home appraised at $400,000 that parents sell to their child for $300,000. The $100,000 gap is the gift, and it’s the number the IRS uses for gift tax purposes. The $300,000 sale price is what matters for capital gains. Nothing about being family collapses these into a single event; they’re tracked separately, and getting one right doesn’t excuse getting the other wrong.
Gift Tax Reporting for the Parents
The gift portion rarely produces an actual tax bill, but it usually produces a filing obligation. In 2026, each person can give up to $19,000 per recipient without reporting anything. A married couple can combine exclusions, sheltering $38,000 per recipient with no return required.3Internal Revenue Service. Gifts and Inheritances
When the gift exceeds those thresholds, the parents file IRS Form 709 by April 15 of the year after the sale.4Internal Revenue Service. Instructions for Form 709 The return doesn’t come with a check. It documents how much of the parent’s $15 million lifetime exemption has been used, a figure that rose from $13.99 million in 2025.1Internal Revenue Service. What’s New – Estate and Gift Tax Unless a parent has already given away tens of millions over a lifetime, no gift tax is due.
In the $400,000-for-$300,000 example, married parents would apply their combined $38,000 exclusion to the $100,000 gift, report $62,000 on Form 709, and reduce their remaining lifetime exemption by that amount. Paperwork, not payment.
Capital Gains on the Sale Portion
The $300,000 that actually changes hands can trigger capital gains tax for the parents. The gain equals the sale price minus the parent’s adjusted basis, which is what they originally paid plus the cost of capital improvements over the years.5Internal Revenue Service. Property (Basis, Sale of Home, etc.) 3
Improvements that add to a home’s value or extend its useful life increase basis; routine maintenance generally doesn’t.6Internal Revenue Service. Publication 523 – Selling Your Home Parents who’ve owned the home a long time should pull records for every major project before calculating the gain.
The Primary Residence Exclusion Still Applies
Parents who owned and lived in the home as their primary residence for at least two of the five years before the sale can exclude up to $250,000 of gain from income, or $500,000 for a married couple filing jointly.7Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence The exclusion works the same way in a sale to a child as in any other sale. Between the exclusion and a lifetime of documented improvements, many parents end up owing no capital gains tax at all, even on a home that has appreciated dramatically.
A Loss Isn’t Deductible
If the sale price falls below the parent’s adjusted basis, the math produces a loss on paper. Federal law prohibits deducting it. Parents and children are related parties, and no loss from a direct or indirect sale between related parties is allowed.8Office of the Law Revision Counsel. 26 US Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Persons This catches families off guard in markets where values have slipped.
The Child’s Basis Is Lower Than From an Inheritance
The child’s cost basis controls their eventual capital gains bill if they ever sell. In a bargain sale, the child’s basis is the greater of what they paid or the parent’s adjusted basis at the time of transfer.9eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale For long-held, appreciated homes, that usually means the sale price, because the parent’s original cost is lower. Either way, the child does not get a basis equal to the home’s full market value.
Inheritance works differently. A child who inherits the property receives a stepped-up basis equal to the fair market value on the date of the parent’s death, erasing all the appreciation that built up during the parent’s lifetime. A child who inherits a $400,000 home that the parent bought for $100,000 has a $400,000 basis and owes nothing if they sell at $400,000.
The same child buying that home for $300,000 now takes a $300,000 basis. If they later sell at $400,000, they owe capital gains tax on $100,000 of profit, which can run $15,000 to $25,000 in federal tax depending on their income bracket. When the parent doesn’t need the sale proceeds, the numbers often favor waiting. The step-up at death is frequently the better deal for the child.
Financing the Purchase
Family or not, the child still needs cash, a mortgage, or both to close.
Lenders Look Harder at Family Sales
A parent-to-child sale is a non-arm’s-length transaction, and underwriters scrutinize it for inflated appraisals, hidden side deals, and fraud.10Fannie Mae. Purchase Transactions The child provides the same documentation any buyer would: income, credit, bank statements. Some programs tighten their rules for family purchases; FHA loans, for example, may require a larger down payment than the standard 3.5%.
Gift of Equity as the Down Payment
The discount itself can function as the down payment. In the $400,000-for-$300,000 example, the $100,000 gift of equity clears a 20% down payment threshold, and the child finances only the $300,000 sale price without putting cash down. Fannie Mae permits gifts of equity on primary residences and second homes and allows them to cover down payment and closing costs.11Fannie Mae. B3-4.3-05 – Gifts of Equity The lender will require a signed gift letter, and the settlement statement must reflect the equity gift. Skipping the documentation can stall or kill the loan.
Seller Financing and the Applicable Federal Rate
Some parents lend the money themselves and collect monthly payments. The flexibility is real, and so is the tax trap. If the parent charges less interest than the IRS’s Applicable Federal Rate, the shortfall is treated as an additional gift, and the parent is taxed on “imputed interest” they never actually received.12Office of the Law Revision Counsel. 26 US Code 7872 – Treatment of Loans With Below-Market Interest Rates The AFR changes monthly. As of April 2026, the long-term rate (for loans over nine years, which covers most home financing) was 4.62% compounded annually.13Internal Revenue Service. Revenue Ruling 2026-7 – Applicable Federal Rates for April 2026 Check the current month’s rate before setting terms, and put the loan in a written promissory note. Without formal documentation, the IRS can reclassify the whole thing as a gift.
Medicaid Look-Back Can Undo the Whole Plan
Families focused on income tax often miss this, and it’s where a bargain sale can do the most financial damage. When a parent applies for Medicaid long-term care benefits, the state reviews asset transfers made during the previous 60 months. A below-market sale falls squarely inside that review. The discount is treated as a gift of assets and can trigger a penalty period during which the parent is ineligible for Medicaid-covered nursing home care.
The penalty length depends on the size of the discount and the average cost of nursing home care in the parent’s state. A $100,000 discount in a state where nursing homes average $10,000 per month works out to roughly 10 months of ineligibility. There’s no ceiling. A parent who needs long-term care within five years of the sale could face tens of thousands in out-of-pocket costs Medicaid would otherwise have covered.
Parents in their 70s or older, or with health conditions that could lead to long-term care needs, should consult an elder law attorney before signing anything. Some states allow a penalty to be cured if the transferred assets are returned, but the process is complicated and not guaranteed.
Property Tax Reassessment
Transferring the property can trigger a property tax reassessment. In many jurisdictions, the county assessor updates the assessed value to current market value, which can raise the child’s annual property tax bill well above what the parent was paying.
Some states offer exclusions or partial protections for parent-to-child transfers, sometimes letting the child keep the parent’s lower assessed value. These exclusions typically require the child to use the property as a primary residence and to file specific paperwork with the county. Rules vary state by state and often county by county. The only reliable answer comes from the local assessor’s office before closing.
Making the Transfer Legally Sound
Skipping formalities because everyone’s family is how disputes, title problems, and tax complications surface years later.
Get an Independent Appraisal
A professional appraisal fixes the fair market value that determines the size of the gift, the lender’s loan-to-value ratio, and the Form 709 reporting. The appraiser should follow the Uniform Standards of Professional Appraisal Practice.14Internal Revenue Service. Publication 561 – Determining the Value of Donated Property If the IRS ever challenges the valuation, that appraisal is the family’s evidence.
Purchase Agreement, Title, and Insurance
A written purchase agreement spells out the sale price, any gifted equity, contingencies, and the closing timeline. A title search confirms the parent’s clear ownership with no outstanding liens or claims. The child should buy a new owner’s title insurance policy; the parent’s existing policy doesn’t transfer to a new owner, so without a new policy the child has no coverage.
Deed and Recording
The transfer happens through a deed the parent signs and delivers to the child. The deed then goes on record with the county recorder’s office. Until it’s recorded, the transfer isn’t effective against third parties. Recording fees are usually modest, but some states and localities charge transfer taxes ranging from a flat fee to a percentage of the sale price.
When the gift portion is large or the parent has significant assets, a real estate attorney and a tax advisor are worth the fees. Professional costs are small next to what a poorly structured family sale can trigger in taxes and lost benefits.