Selling house to family member below market value is a legal but complex financial transaction. Homeowners often choose this option to help family members afford a home or to keep the property within the family.
However, this type of sale involves tax implications, mortgage lender restrictions, and legal paperwork. Without careful planning, it can lead to unexpected tax liabilities, financing issues, or even IRS audits.
This guide explains the legal and financial considerations of selling a home below fair market value (FMV), how gift taxes apply, how capital gains tax impacts both parties, and the correct steps to take to ensure compliance with IRS rules and real estate laws.
What Does It Mean to Sell Below Market Value?
Fair Market Value (FMV) is the price a home would sell for under normal market conditions. FMV is determined by factors such as:
- Recent comparable home sales (comps) in the area
- Professional home appraisals
- Supply and demand in the real estate market
If a home is sold for significantly less than its FMV, the IRS considers the price difference a taxable gift. The seller may need to report the transaction on IRS Form 709 and the buyer could face higher capital gains taxes when reselling the home.
How the IRS Treats Below Market Sales: Gift Tax Rules
The IRS applies gift tax rules when a property is sold below its fair market value. The difference between FMV and the sale price is classified as a gift if it exceeds the annual gift tax exclusion limit.
Updated Gift Tax Exemptions and Reporting for 2025
- The annual gift tax exclusion for 2025 is $19,000 per recipient (up from $18,000 in 2024).
- The lifetime gift and estate tax exemption is $13.61 million per person in 2024 (adjusted annually for inflation).
- If the price reduction exceeds $19,000 in 2025, the seller must file IRS Form 709 to report the excess amount, even though gift tax is rarely owed.
- Gift tax is paid by the giver, not the recipient, but most people never actually pay gift tax because they stay below the lifetime exemption limit.
When Form 709 is Required for a Below-Market Sale
A home seller must file a gift tax return (Form 709) by April 15 of the year following the sale if any of these apply:
- The seller discounted the home price by more than $19,000 in 2025 ($18,000 in 2024).
- The seller and their spouse wish to split the gift value, doubling the annual exclusion to $38,000 in 2025 ($36,000 in 2024).
- The seller gave a future interest in the home (e.g., the buyer cannot take ownership until a later date).
- The seller gave their spouse an interest in the home that terminates on a future event (e.g., a life estate, where ownership ends upon death).
Even if no immediate tax is due, failing to file Form 709 can lead to IRS penalties or audits.
Example of Gift Tax Calculation for 2025
- A home has a fair market value of $500,000 but is sold to a family member for $450,000.
- The $50,000 discount exceeds the $19,000 annual gift tax exclusion.
- The seller must file Form 709 to report the $31,000 excess gift ($50,000 – $19,000 exclusion).
- No immediate tax is owed unless the seller has exceeded their lifetime gift tax exemption ($13.61 million in 2024).
Capital Gains Tax Consequences for Seller & Buyer
How Capital Gains Tax Affects the Seller
- If the home has increased in value, the seller may owe capital gains tax on the profit.
- The IRS allows sellers to exclude up to $500,000 (married) or $250,000 (single) in capital gains if the home was their primary residence for at least two of the last five years.
- If the seller does not qualify for this exclusion, they may owe capital gains tax of 15%-20% on the profit.
How Capital Gains Tax Affects the Buyer
- The buyer’s cost basis is the seller’s original purchase price, not the discounted sale price.
- If the buyer sells the home in the future, they may owe higher capital gains taxes since their taxable gain will be larger.
Example of Capital Gains Tax Calculation
Scenario:
- Original purchase price: $200,000
- FMV at time of sale: $500,000
- Sold to a family member for: $300,000
- IRS considers cost basis: $200,000 (not $300,000)
- Buyer later sells home for: $600,000
- Taxable gain: $400,000 ($600,000 – $200,000)
Although the buyer paid $300,000, their taxable gain is based on the seller’s original purchase price ($200,000), resulting in a higher capital gains tax when they sell.
Understanding these capital gain tax implications ensures both parties avoid financial surprises in the future.
6 Steps to Selling House Below Market Value to a Family Member
1. Obtain an Accurate Home Appraisal
Before finalizing the sale price, a licensed appraiser should evaluate the home to determine fair market value.
This protects both parties and helps prevent IRS scrutiny over suspiciously low sale prices, ensure mortgage lenders accept the sale price if the buyer needs financing, and avoid family disputes over whether the sale price is fair.
If the IRS audits the transaction, an official appraisal serves as proof of the home’s actual market value.
2. Choose a Sale Method: Discounted Price vs. Gift of Equity
Sellers can structure the sale in two ways. One option is an outright discount, where the home is sold at a lower price, with the difference reported as a gift.
The other option is a gift of equity, where the home is sold at full price but “gifting” a portion of the home’s value, allowing the buyer to use it as a down payment for a mortgage.
A gift of equity is useful when the buyer cannot afford a large cash down payment, helping them qualify for a home loan while reducing tax complications.
3. Address Mortgage & Lender Requirements
If the home still has a mortgage, the lender must approve the sale before closing. Selling too far below FMV without lender approval could be considered mortgage fraud.
If the buyer needs financing, the lender will require a home appraisal and may not approve a mortgage if the sale price is too low.
4. Prepare the Legal Paperwork
Selling to a family member still requires standard real estate paperwork, including a purchase agreement outlining the sale price and terms, a gift of equity letter if applicable, deed transfer documents such as a Warranty Deed, Quitclaim Deed, or Special Warranty Deed, and IRS Form 709 if the discount exceeds the gift tax exemption.
A real estate attorney should review the documents to ensure the sale follows legal and tax regulations.
5. Report the Sale to the IRS
If the price reduction exceeds $19,000, the seller must file IRS Form 709.
While this usually does not result in immediate taxes, failing to report the sale could trigger IRS audits and penalties.
6. Check Property Tax Impacts
Selling below market value may trigger property tax reassessments, depending on state laws.
California’s Proposition 19 removed automatic property tax exemptions for parent-to-child transfers, potentially increasing the buyer’s property taxes.
Some states allow tax exemptions for family transfers, but requirements vary.
Sellers should consult the local tax assessor to understand potential property tax changes.
3 Common Mistakes to Avoid
Selling Too Low Without Documentation: If the IRS questions the sale, a lack of a professional appraisal may cause legal issues. Proper documentation prevents fraud accusations from lenders and tax authorities.
Failing to Consider Future Capital Gains: Buyers should calculate future tax costs before agreeing to a below-market sale. If the home is inherited instead, the step-up in basis rule can reduce capital gains tax.
Not Consulting a Real Estate Attorney or CPA: A legal professional ensures all contracts, tax forms, and lender approvals are properly handled. They help avoid unexpected financial penalties from the IRS or mortgage lenders.
Bottom Line – Selling a House to Family Member Below Market Value
Selling a home to a family member below market value is legally possible but requires careful planning to avoid tax and financial issues.
The IRS treats the discounted amount as a taxable gift if it exceeds the exemption limit. Capital gains tax can affect both the seller and the buyer in future sales.
Mortgage lenders must approve below-market-value sales if financing is involved.
Consulting a real estate attorney and tax professional ensures compliance with legal and financial regulations, protecting both parties from costly mistakes.
