Buying a house from a family member works like any other real estate purchase on paper, but the price you set, the way you finance it, and the seller’s own tax situation all get closer scrutiny from the IRS and any lender involved. Get an independent appraisal before you agree on a number, put the deal in writing, and check how a discounted price will affect gift tax, the buyer’s future capital gains, Medicaid eligibility, and your local property tax assessment. The rest is paperwork.
Start With an Appraisal
Hire a licensed appraiser before you talk price. The IRS defines fair market value as the price an unrelated buyer would pay under normal conditions, and that figure anchors the gift tax analysis, the lender’s loan-to-value calculation, and the buyer’s cost basis going forward. Skipping the appraisal to save a few hundred dollars leaves you with no defense if the IRS later recharacterizes the sale.
Selling below the appraised value is common and perfectly legal. Just understand what happens: the IRS treats the difference as part sale, part gift. A parent who sells a $500,000 home to a child for $350,000 has made a $150,000 gift.1Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets That gift has consequences on both sides of the deal.
How a Discounted Price Becomes a Gift
Two layers of federal protection stand between a family gift and any actual tax bill. The first is the annual exclusion: any person can give up to $19,000 per recipient per year without reporting anything.2Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 20263Office of the Law Revision Counsel. 26 USC 2503 – Taxable Gifts A married couple selling together can each use that exclusion, shielding $38,000 of the discount. If the buyer is also married, gift-splitting can push the shielded amount to $76,000.
Once the gift portion exceeds those thresholds, the seller must file IRS Form 709. Filing does not usually mean paying. The excess simply gets recorded against the seller’s lifetime gift and estate tax exemption, which sits at $15 million for 2026.4Internal Revenue Service. What’s New – Estate and Gift Tax Very few families ever reach that cap. But the filing itself is not optional, and skipping it can leave the statute of limitations open on the gift indefinitely.5Internal Revenue Service. Instructions for Form 709 (2025)
What the Discount Does to the Buyer’s Cost Basis
Here is where a generous family price can quietly cost the buyer money years later. In a bargain sale, your cost basis in the property is the greater of what you actually paid or the seller’s adjusted basis.6Internal Revenue Service. Publication 551 – Basis of Assets7Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust It is not the current market value.
Take the parent-child example again. The parent’s basis was $200,000, the home appraises at $500,000, and the child pays $350,000. The child’s basis becomes $350,000. If the child later sells for $600,000, the taxable gain is $250,000. Had the child bought the same house from a stranger at full market value, basis would have been $500,000 and the eventual gain only $100,000. The family discount effectively transferred $150,000 of future capital gains liability to the buyer. That does not make the discount a bad idea. It does mean both sides should run the numbers before settling on a price.
The Seller’s Capital Gains Picture
A family sale does not disqualify the seller from the Section 121 home-sale exclusion, which shelters up to $250,000 in gain for a single filer and $500,000 for a married couple filing jointly. The seller must have owned and lived in the home as a principal residence for at least two of the five years before the sale.8Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence The only related-party restriction in Section 121 targets sales of a remainder interest, which almost never comes up in a straightforward purchase.9Internal Revenue Service. Publication 523 (2025), Selling Your Home
In a bargain sale, the seller only recognizes gain on the sale portion, not the gift portion.1Internal Revenue Service. Publication 544 (2025), Sales and Other Dispositions of Assets Combined with the Section 121 exclusion, most sellers of a longtime family home owe nothing at all.
Financing Options and Their Family-Specific Rules
Conventional Mortgages
Conventional lenders will finance a family purchase and will order their own appraisal regardless of the agreed price. The main advantage of a family deal on the financing side is the gift of equity: the seller’s discount can substitute for a cash down payment, letting the buyer close with less money out of pocket. The lender still has to verify the loan-to-value ratio meets its guidelines.
FHA Loans
FHA classifies family sales as “identity of interest” transactions and normally caps the loan-to-value ratio at 85 percent, meaning a 15 percent down payment instead of the usual 3.5 percent. Two exceptions restore the standard rules: when the buyer is purchasing a family member’s principal residence, or when the buyer has been renting the property for at least six months before signing the purchase contract.
Seller Financing
Some families cut out the bank and have the seller carry the loan. Done properly, that means a formal promissory note and a recorded mortgage or deed of trust securing the debt against the property. Without those documents, the buyer cannot deduct mortgage interest, and the arrangement looks casual enough to invite IRS scrutiny.
The interest rate on a seller-financed loan has to meet or exceed the IRS Applicable Federal Rate for the month the loan is made.10Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates The IRS publishes the AFR monthly, and it varies by loan term. The long-term AFR (for loans over nine years) was around 4.55 percent in late 2025.11Internal Revenue Service. Revenue Ruling 2025-24 Set the rate below the AFR and the IRS will impute interest income to the seller, meaning the seller owes tax on interest they never actually collected. That is an unpleasant surprise for a parent who thought they were just being generous.
The Existing Mortgage Problem
If the seller still has a mortgage on the property, transferring ownership normally triggers a due-on-sale clause that lets the lender demand the balance in full. The Garn-St. Germain Act carves out a federal exception for family: a lender cannot enforce the due-on-sale clause when a borrower’s spouse or children become owners of a residential property with fewer than five units.12Office of the Law Revision Counsel. 12 USC 1701j-3 – Preemption of Due-on-Sale Prohibitions
The protection stops there. The seller’s name stays on the loan, and they remain legally responsible for payments if the buyer ever defaults. That lingering liability also sits on the seller’s debt-to-income ratio, which can block them from qualifying for a new mortgage of their own. The clean fix is for the buyer to refinance into their own loan as soon as they can qualify. Until then, Garn-St. Germain at least prevents the lender from calling the loan due on the spot.
Paperwork That Protects the Buyer
The Purchase Agreement
State law generally requires real estate contracts to be in writing and signed by both parties, and that applies to family just as it applies to strangers. The agreement should identify both sides by full legal name, state the purchase price, and use the property’s legal description from the current deed rather than the street address. Family deals often include an as-is clause, but most states still require a written disclosure of known defects like structural damage, water intrusion, or lead paint. Get the disclosure done even if both sides think it is unnecessary.
Gift of Equity Letter
When the seller’s discount is being used toward the buyer’s down payment, the lender will require a Gift of Equity letter. It has to state the dollar amount of the gift, the relationship between buyer and seller, and an explicit declaration that no repayment is expected.13Fannie Mae. B3-4.3-05, Gifts of Equity The gift of equity can cover down payment and closing costs, but it cannot count toward the buyer’s financial reserves.
The Deed
Families often default to a quitclaim deed because it is cheap and simple, but a quitclaim offers no guarantees about title. If an unknown lien or boundary problem surfaces later, the buyer has no recourse against the seller through the deed itself. A warranty deed carries the seller’s legally binding promise that the title is clear. Lenders typically require one anyway. Even in an all-cash family deal, the small additional cost buys real protection.
Title Insurance
This is where family deals quietly go wrong. Skipping the title search because everyone thinks they know the property’s history misses the point of the search. A parent may not know about a contractor’s lien from an old renovation or a judgment lien recorded years ago. Title insurance protects the buyer against defects that existed in the public record at closing, plus certain hidden risks like forgeries or missing heirs, for as long as the buyer owns the home. The one-time premium is typically a fraction of one percent of the purchase price.
Two Traps Families Miss
Medicaid Look-Back
If the selling family member might need Medicaid-funded long-term care within the next several years, a below-market sale can create an eligibility problem. Federal law imposes a 60-month look-back period: any transfer for less than fair market value made within five years of a Medicaid application is presumed to have been made to qualify for benefits.14Office of the Law Revision Counsel. 42 USC 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets The state Medicaid agency calculates a penalty period by dividing the uncompensated value of the transfer by the average daily cost of nursing home care in the area. During that period, the applicant is ineligible for Medicaid coverage of nursing home or waiver services.
Some family transfers are exempt from the penalty. Transferring a home to a spouse, a child under 21, or a child who is blind or permanently disabled does not trigger the look-back. Neither does transferring to a sibling who already has an equity interest in the home and has lived there for at least a year, or to an adult child who lived in the home for at least two years before the parent entered a nursing facility and provided care that let the parent stay at home.14Office of the Law Revision Counsel. 42 USC 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets These exceptions are narrow. If Medicaid is even a remote possibility, talk to an elder law attorney before setting the price.
Property Tax Reassessment
Transferring a home can trigger a reassessment that resets the property to current market value and raises the annual tax bill. Rules vary sharply. Some states preserve the existing assessed value for parent-to-child transfers; others reassess every transfer regardless of relationship. Because this is entirely a matter of local law, call the county assessor’s office before closing and find out what the new tax bill will look like. It is the single most reliable way to avoid a surprise the first year the buyer owns the home.