“It can be more challenging than you imagine selling a house to a family member. While you might try to save money by buying a house on your own without professional assistance, you may encounter issues—such as potential tax implications or family issues—that you would otherwise avoid if you had a professional assist you.”
Whether you’re transferring property intra-family, here are some tips you’ll want to keep in mind when Intra Family Property Transfer.
Why is an intra-family property transfer different?
You are said to be at arm’s length in an arm’s length transaction when you sell your home to a stranger, which means the two parties agreed to the purchase agreement independently and without any ties between them.
Both parties must negotiate for the best price; in most cases, an appraiser representing the lender will confirm this.
It is, however, not considered an arm’s length transaction by the IRS when you are related to the person involved in the transaction. To determine if the sales price reflects the fair market value or if the seller is presenting a gift of a lower sale price to the buyer, the IRS will examine the sales price.
How Is a Gift Price Defined?
According to the IRS, fair market value is what a willing buyer and a willing seller, with reasonable knowledge of relevant facts, would agree to exchange for a property. The IRS may require you to report that you gave the buyer a gift if you sell at a price below fair market value.
Individual gift exclusions for 2020 and 2021 are $15,000 and $30,000. This is the maximum amount you can discount a sale without having to report it to the IRS as a gift. An inspection and a consultation with a realtor and appraiser can help determine the home’s fair market value.
It is unlikely that you will need to pay taxes if you provide a gift when you sell your home—no gift tax is needed as of 2020 unless you have given this person more than $11.58 million in their lifetime.
For the IRS to track how much you’ve given in gifts over your lifetime, you’ll still need to file a tax return if you exceed the gift limit for the year.
Pitfalls of Intra-Family Real Estate Transactions
Federal Gift Tax & Estate Tax
It is possible the need to report taxes when you gift property with a value that exceeds a certain threshold amount. It is possible to use portions of one’s exemptions under the Federal Gift Tax and Estate Tax inefficiently, negatively impacting potential future tax liabilities (under this complex and specialized federal tax system).
The income tax implications of gifting a property interest may be severe. When older adults give real property to their children (when they later sell it), they often fail to understand the income tax implications. Due to these income tax ramifications, it is often best to keep the property until an elder dies. Renting the property, taking out a loan, or obtaining a reverse mortgage may make more sense if older adults need funds to maintain or enhance their lifestyle.
Many parent-child real estate transfers may qualify for significant reassessment exclusions. It is important to know whether a particular transaction qualifies for reassessment exclusion, and we can promptly submit certain forms to the Assessor. There is a possibility of forfeiting the benefit if these rules and procedures are not strictly followed.
Who Pays the Gift Tax?
Donors are generally responsible for paying gift taxes, not the buyer. The basic tax risk is if you give the entire home to the recipient — the recipient will inherit your tax basis for the house. If your family member sells the home for $300,000 a few years later, the taxable gain for the family member could be $250,000 if you had a $50,000 tax basis for the home when you bought it.
Family property transfer: Adding a joint owner
Your home will automatically pass to your family members upon death if you add another family member as a joint owner.
It is a gift of 50% of the fair market value of a property to add a family member as a joint owner without consideration. For gift tax purposes, the donor must report a gift that exceeds the annual exclusion limit ($16,000 for 2022) on a gift tax return (Form 709).
Since both gift and estate taxes are exempt for 2022, they are unlikely to owe gift tax. On the date of the transfer, the basis of each owner’s ownership interest must also change.
To calculate estate tax, the personal representative of the deceased owner(s) must include the fair market value of the deceased’s an ownership interest in the estate tax gross estate.
As a result, the surviving owner receives the decedent’s ownership interest on a stepped-up basis (generally the same amount as the decedent’s gross estate) for the inherited property.
The surviving owner calculates the gain or loss when the home sells by adding the stepped-up basis in the inherited portion to the basis received when the gift was made.
A family member can be added to the deed even if they retain the right to use the home exclusively for the rest of their life. This situation may result in a life estate.
Family property transfer: Gifting real estate
Your child or grandchild inherits a real estate property.
The IRS considers a plot of land a gift if you give it to your child or grandchild. Gifts of real estate to your children or grandchildren are not tax deductible. So the tax issue is about expenditures, not savings. You can’t claim a loss even if the paperwork shows you sold the house for $1 or another nominal amount.
For example, a donor who gifts land worth $500,000 without receiving anything of that value may face tax consequences. For 2022, you can give $16,000 (2022) tax-free to anyone you like.
In the case of a married couple, you may both give $16,000 (for 2022). However, if the gift exceeds the annual exclusion amount, you, as the donor, must file a gift tax return (Form 709). The unified gift and estate tax exemption will likely mean you won’t owe any gift tax if you have yet to use it. Real estate transactions can be difficult to avoid from a tax standpoint, so do your research to plan.
Basic Steps for Selling Your House to a Family Member
Agree on the process
You need to agree on the process before deciding on a price. By identifying whether you want a professional (like a Realtor or appraiser), discussing the financing of the purchase, and setting a timeline, you can reduce confusion and conflict down the road. Additionally, you need to specify who handles deciding for both parties so that there will be clarity if other parties intervene.
· Hire Professionals
A major transaction, such as a home purchase, can cause hiccups, even if you have a good relationship with your family member. Even if you think you don’t need a real estate agent, they still need to ensure all state-required property disclosures exist, the purchase contract is drafted properly, and the home sells for fair market value.
A real estate agent can work for both parties for a flat fee or a heavily discounted commission. An attorney can also draw up and review key documents; either one lawyer can handle the process, or both parties may need one. Getting an appraisal (usually required by a lender) is also a good idea if a lender isn’t involved.
· Evaluate the Home
In most cases, the buyer pays for a professional home inspection. However, if you work with a real estate agent, they will provide a comparative market analysis, which the appraisal confirms.
· Agree on a Price
If you wait until after the inspection, you can agree on a price based on the agent’s estimate and appraisal. You’ll want your purchase contract to include relevant contingencies, such as voiding it if the buyer cannot secure a mortgage by a certain date.
· Proceed to Close
You will likely need the help of a real estate lawyer if the purchase involves a lender. You may opt for a seller-financed arrangement, which involves you drawing up a promissory note that includes the loan terms and recording it with the local government. A lawyer may be able to assist you in ensuring the note is drafted correctly, and the terms are acceptable.
How can you buy a home from your family member?
A family member buying a home from you is an opportunity to protect your interests, especially if the seller is pushing for the transaction to proceed without the help of an attorney.
It is your responsibility as a buyer to:
· Get a professional price estimate.
Sellers often believe their homes are more valuable than they are, especially if you’re buying a family home that holds priceless memories for years to come. To be sure you’re getting a good price, an impartial third party will examine comparable homes in the area and the home’s current condition.
· Secure legal representation.
Many regulations and potential pitfalls are involved in buying a house, so you must have a lawyer on your side, even if both you and the seller agree on one. Having an attorney on your side can help ensure that all contingencies are in your purchase contract; you can review the title for liens and get the required property disclosures.
· Hire an inspector.
The inspector’s report will give you an unedited view of the home’s condition and highlight major issues that may affect its sale price. You can buy peace of mind by hiring your home inspector for a few hundred dollars or more.
· Make sure it’s the right home for you.
If you can help a family member out financially or medically and need to move, buying their home might seem like a generous act. However, if the home or community is wrong for you, it may not be worthwhile.
Techniques Involving Asset Sales
When a family member purchases a property on an installment basis, the appreciation of the property passes to the family member. The arrangement must be in writing to create a legally enforceable obligation if the purchase price is “full and adequate consideration.”
In the event of the payee’s death, the note’s unpaid balance remains in the taxable estate. The sale of the property can secure invoices.
Death Terminating Notes:
There is also a version of the installment sale that uses promissory notes that expire upon the death of the payee, known as SCINs or Self-Cancelling Installment Notes. It has several advantages over a promissory note, including the ability to require security (as well as shifting appreciation).
Still, when the payee dies, the unpaid balance of the note is zero, so nothing will remain in the estate. Similarly to any installment note, the purchase price must reflect a “full and adequate consideration.”
Still, it must also exceed the value of the sold property to qualify as an installment note. To ensure that the note’s value is sufficient to pay for the property, an additional premium must be paid for the feature that may expire before the payee receives payments equal to the note’s face amount.
The primary drawback to this approach is determining how much the death-termination component of the premium should be. It would be highly advisable that one consult a qualified expert for advice.
Private annuities are contracts that provide specified payments to the named annuitant throughout the annuitant’s life. In a similar manner to a death-terminating promissory note, a private annuity guarantees payments for the duration of the annuitant’s life, even if the annuitant outlives the expected life expectancy of the annuitant.
In addition to determining the amount of the annuity based on IRS valuation tables, private annuities also eliminate guesswork regarding payments. If a person has a much shorter life expectancy than 18 months, I recommend a private annuity if two doctors sign a statement stating they have a greater than 50% chance of living at least one year.
A family house transaction can be easy and affordable, but it’s best to be ready for complications. You’ll want to hire the right professionals to meet all local, state, and federal regulations and ensure both sides receive a fair deal.