Buying a house from a family member follows the same path as any other home purchase, but a handful of extra rules apply because the IRS and mortgage lenders treat sales between relatives as non-arm’s-length transactions. If the price comes in below fair market value, you’ll be dealing with a gift of equity, possible gift tax reporting, stricter loan-to-value limits, and a cost basis that carries over from the seller. For older sellers, a discounted sale can also jeopardize future Medicaid eligibility. The steps below walk through what changes when the seller is family and what stays the same.
Get an Independent Appraisal First
Before you settle on a price, hire a state-certified or licensed appraiser to establish the home’s fair market value. Federal regulations require this for any federally related residential mortgage, and your lender will insist on it regardless of how familiar you are with the property.1eCFR. 12 CFR 34.43 – Appraisals Required; Transactions Requiring a State Certified or Licensed Appraiser
The appraised value anchors every other decision. It fixes how much equity the seller is giving away, caps how much the lender will finance, and gives you a defensible number if the IRS later questions whether a sale was really a disguised gift. Without one, you have nothing to point to.
How a Gift of Equity Works
When a relative sells you the home for less than its appraised value, the gap between the two numbers is a gift of equity. If the house appraises at $300,000 and your relative sells it to you for $220,000, the $80,000 difference is the gift. Lenders generally let that amount count as your down payment.2Fannie Mae. Gifts of Equity
To use it, the seller signs a gift letter stating the dollar amount and confirming no repayment is expected. The lender needs that letter to rule out a hidden side loan that would change your debt-to-income ratio. Both parties should also have bank statements ready, since lenders scrutinize fund movement more closely in family deals.
When the Seller Has to File a Gift Tax Return
If the gift of equity is $19,000 or less — the federal annual gift tax exclusion for 2026 — the seller has no filing obligation.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 If both the seller and their spouse own the home, each can give $19,000, doubling the exclusion to $38,000 before any reporting kicks in.
Above that threshold, the seller must file IRS Form 709 to report the transfer.4Office of the Law Revision Counsel. 26 U.S.C. 2503 – Taxable Gifts Filing doesn’t mean tax is owed. The excess simply counts against the seller’s lifetime gift and estate tax exclusion, which is $15,000,000 for 2026.5Internal Revenue Service. What’s New – Estate and Gift Tax Actual gift tax applies only once lifetime gifts exceed that figure, so very few family home sales produce a tax bill. The Form 709 filing, however, is mandatory whenever the annual exclusion is exceeded.
Mortgage Rules That Only Apply to Family Sales
Lenders apply tighter rules to family transactions because the relationship creates a risk that the price or terms don’t reflect a real market deal. The specifics depend on the loan type.
FHA Loans
The FHA caps the loan-to-value ratio at 85 percent for identity-of-interest transactions, which include any sale between family members.6HUD. FHA Single Family Housing Policy Handbook You need at least 15 percent equity, well above the usual 3.5 percent FHA minimum. A gift of equity can cover this requirement.
Two situations waive the 85 percent cap:
- You’re buying the seller’s current principal residence and plan to live in it yourself. The standard FHA LTV limits then apply.
- You’ve been renting the property for at least six months before signing the sales contract. You’ll need a lease or other written proof of tenancy.
Conventional Loans
Fannie Mae permits non-arm’s-length transactions on existing properties without the blanket LTV restriction the FHA imposes.7Fannie Mae. Purchase Transactions The lender will still verify that the sale is legitimate, that you intend to occupy the home as your primary residence, and that the gift-of-equity paperwork is complete. Individual lenders can layer on additional conditions.
Occupancy
Both FHA and conventional lenders generally require the buyer to occupy the home as a primary residence. On FHA loans, at least one borrower must move in within 60 days of closing. Investment or second-home purchases from family members face far fewer financing options and often stricter identity-of-interest treatment.
Seller Financing and Imputed Interest
Some families skip the bank and have the seller finance the purchase through a private mortgage or installment agreement. If you go this route, the loan must charge at least the applicable federal rate (AFR) that the IRS publishes monthly. Charge less, and the IRS treats the loan as if interest were being paid at the AFR, a rule called imputed interest.8Office of the Law Revision Counsel. 26 U.S.C. 7872 – Treatment of Loans With Below-Market Interest Rates
The result: the seller has to report that phantom interest as income even though they never received it. AFRs change each month and are split into short-term (up to three years), mid-term (three to nine years), and long-term (over nine years) categories.9Internal Revenue Service. Applicable Federal Rates Check the current month’s rate before setting your terms. A zero-interest family loan can hand the seller an unexpected tax bill.
Purchase Agreement and Required Disclosures
You still need a written purchase contract. Trust aside, no lender will fund the loan without one. Standard residential purchase agreements are available through real estate attorneys, legal form providers, or local bar associations.
Make sure the contract covers:
- The purchase price, plus the gift of equity amount if the price is below fair market value.
- An inspection contingency giving you the right to hire a professional inspector within a set window, typically 10 to 14 days. Family sellers often don’t know about hidden structural problems any better than strangers do.
- A financing contingency that lets you walk if the mortgage falls through.
- A list of appliances, fixtures, and personal property that stay with the home.
- The exact legal description from the current deed or tax records. Any mismatch with the deed can delay closing or cloud the title.
The seller also has to provide the same disclosures required in any other sale. Federal law requires sellers of homes built before 1978 to deliver a lead-based paint disclosure and the EPA’s lead hazard pamphlet before the buyer is contractually bound, along with a 10-day window to conduct a lead inspection unless both parties agree otherwise.10Office of the Law Revision Counsel. 42 U.S.C. 4852d – Disclosure of Information Concerning Lead Upon Transfer of Residential Property Skipping the lead disclosure knowingly can expose the seller to civil penalties and liability for up to three times the buyer’s damages. Most states layer on additional disclosure requirements for known material defects such as foundation issues, roof leaks, or past flooding. The family relationship does not exempt either side from any of these rules.
Capital Gains and the Cost Basis You Inherit
Both parties should understand how a below-market family sale affects their taxes.
The Seller’s Exclusion
A seller who has owned and used the home as a primary residence for at least two of the five years before the sale can exclude up to $250,000 of capital gains ($500,000 for a married couple filing jointly).11Office of the Law Revision Counsel. 26 U.S.C. 121 – Exclusion of Gain From Sale of Principal Residence The exclusion applies to family sales just like any other, and it can be used only once every two years.
Your Cost Basis as the Buyer
Buying at a discount changes your starting point for calculating your own future capital gains. In a bargain sale where you pay something but also receive a partial gift, your basis is generally the greater of what you paid or the seller’s adjusted basis.12Office of the Law Revision Counsel. 26 U.S.C. 1015 – Basis of Property Acquired by Gifts and Transfers in Trust If the property transfers entirely as a gift with no payment, your basis is typically the donor’s adjusted basis, not the current market value.13Internal Revenue Service. Property (Basis, Sale of Home, Etc.)
A lower basis means a bigger taxable gain down the road. Say your parent bought the home for $120,000 and sells it to you for $200,000 when it’s worth $350,000. If your basis is $200,000, you’ll owe capital gains tax on appreciation above $200,000 when you eventually sell, not above $350,000. Living in the home long enough to qualify for the Section 121 exclusion can wipe out much of that gain on an eventual sale, but on higher-value homes the basis difference still bites.
Medicaid Look-Back Period
If the seller is older or may need long-term care within the next five years, selling below market value can create a serious Medicaid problem. Federal law requires states to review all asset transfers made within 60 months before someone applies for Medicaid-funded long-term care.14Office of the Law Revision Counsel. 42 U.S.C. 1396p – Liens, Adjustments and Recoveries, and Transfers of Assets If the state concludes the seller gave away value for less than fair market compensation during that window, it imposes a penalty period of ineligibility for long-term care benefits.15CMS. Transfer of Assets in the Medicaid Program
The penalty length equals the uncompensated value divided by the average monthly nursing home cost in the seller’s state. A $100,000 gift of equity can translate into many months of disqualification. The cleanest approach is to sell at the full appraised value. If a below-market price matters to both sides, talk to an elder law attorney first.
Due-on-Sale Clauses and Informal Transfers
If the seller still has a mortgage on the property, that loan almost certainly includes a due-on-sale clause letting the lender demand full repayment when ownership changes. In a normal family sale where the buyer obtains new financing, this is a non-issue because the existing loan gets paid off at closing from the sale proceeds.
The clause bites when families try to move ownership informally — adding the buyer to the deed or doing a quitclaim transfer while the seller’s mortgage is still in place. Federal law blocks lenders from enforcing the due-on-sale clause for certain transfers, including one where a spouse or child of the borrower becomes an owner.16Office of the Law Revision Counsel. 12 U.S.C. 1701j-3 – Preemption of Due-on-Sale Prohibitions Sales to siblings, parents, cousins, aunts, uncles, or other extended family are not on the protected list. If a transfer falls outside the exempt categories, the lender can call the full balance due.
Closing, Deed Recording, and Transfer Taxes
After the contract is signed and financing is secured, the deal moves to a title company or escrow agent. They run a title search to confirm clear ownership and identify any liens or unpaid taxes, issue title insurance to protect you and the lender from undiscovered claims, and handle the money: collecting your funds, paying off the seller’s existing mortgage, and distributing what’s left to the seller.
At closing, both parties sign the final loan documents and the new deed in front of a notary. The title agent then files the deed with the local county recorder’s office. Recording fees vary by jurisdiction, and the recorded deed usually arrives by mail within several weeks.
Budget for transfer taxes too. Many jurisdictions charge a percentage of the sale price, and the rules vary widely. Some areas exempt family transfers entirely; others apply the full rate regardless of the relationship. Your title company or a local real estate attorney can confirm what you’ll owe in your area.