Selling your home to your children can be a difficult and time-consuming process. According to WashingtonPost.com, this is because the IRS pays extra attention to interfamily transactions. In most cases, the parent's objective is to transfer or gift the deed, but doing this outright comes with a heavy tax burden for the child. A common solution is to have your child buy the home from you by signing a promissory note—or legal IOU—which you can then cancel. However, this is not as easy as it sounds.
Making the Sale Official
The IRS upholds that if a person makes a loan with the intent to forgive or otherwise cancel the promissory note, that loan will be considered prearranged and will be taxed as a gift. To get around this problem, WashingtonPost.com recommends that you make the sale as official as possible, which you can accomplish through a variety of means. First, during the time of the promissory note's signing, do not mention your intention to cancel the debt. Keep the transaction an "arm's length" deal, by treating your child as you would a stranger entering into the contract. You should have your child make annual, quarterly or—preferably—monthly interest payments, the rates for which should be set at least equal to the IRS's long-term applicable federal rate. These payments should help you and your child avoid IRS questioning about gift taxes. In addition, if you secure the promissory note with a deed of trust on your house, your child can deduct the mortgage interest payments he makes to you. For parents feeling extra generous, you can help your child make interest payments and cover costs by giving him up to $12,000 per year, per parent. As of 2010, this is the maximum value of a gift an individual can give tax-free.
Special Power of Appointment
Although not technically a method for selling your home to a child, including a "special power of appointment" clause in your house's deed can help you transfer the deed without having your child incur harsh taxes. According to ringsurf.com, with a typical deed transfer, the child will eventually have to deal with considerable capital gains taxes if he ever decides to sell. With a special power of appointment though, you can transfer the deed to whomever you want, whenever you want, but for tax purposes, that transfer is only considered complete once you have passed away. A child will thus benefit from paying taxes based on the market value of the property at the time of the parent's death, as opposed to ones based on an original acquisition value.