Selling a house to a family member can seem like an ideal solution. The property goes to someone you know, you don't have to find a buyer, and you may be able to give a loved one a property at a reduced price that might be affordable to them. However, selling to a family member increases the complexity of the sale in a number of ways. You'll have to disclose that you know each other, and depending on how low the price is, the Internal Revenue Service may have something to say about the tax burden the sale generates.
Selling a home to a family member qualifies as a non-arm's length transaction, a fancy way of saying that the buyer and seller have a pre-existing relationship. This draws additional scrutiny from both government agencies and lenders because of the potential for fraud. For example, attempting to complete a short sale to a family member for well under the home's value, and then having that family member allow you to stay in the home at a reduced cost raises red flags. For that reason, you'll have to sign an arms-length affidavit as part of any short sale, effectively removing the option of selling the underwater property to family for less than the amount owed on the loan. Even for a conventional sale at or near the appraised value, your lender may apply additional scrutiny to the mortgage application to confirm the transaction is being made in each party's self-interest and not under duress.
Pricing the Property
You may want to sell the property at a reduced price, either because it's for a loved one or because the buyer can't afford to purchase it any other way. However, the IRS takes particular interest in the sale price, because it influences the amount owed in taxes. If you set it too far below the market value, the IRS may consider it a gift and expect you to pay a gift tax on the difference. You also can't deduct a loss on a sale to a friend or relative from your taxes. Moreover, if the family member turns around and sells it too fast, she'll be hit with capital gains taxes. To avoid the latter, the IRS insists that the new owner must use the home as her primary residence for at least two of the five years prior to the sale.
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Getting a Mortgage
The buyer needs to declare the non-arms length transaction during the mortgage application process, and fill out an Identity of Interest form if applying for an FHA loan. You also can arrange the transaction as a private, owner-financed sale, in which your family member makes the agreed-upon amount to you rather than a mortgage company.
Just because you're selling to someone you know doesn't mean you won't need professional help. A title company can help you document that there are no liens against the property, and a real estate lawyer can make sure the deed transfer and other necessary paperwork are filled out properly and documented with the necessary authorities. A lawyer can also help ensure that any lending arrangement doesn't qualify as mortgage fraud.
Selling to Your Child
If you're looking to pass the house on as part of an inheritance to your child, you can make it a gift -- but you'll either have to pay gift taxes or use part of your gift tax or estate tax exemption. If you sell the property, it works the same as it would for a sale to any family member -- there's no special treatment for selling to your child.
Selling your home to a relative has its positives, particularly if it's a property you want to keep in the family, or when it's an opportunity the family member may not have otherwise. However, there are potential negatives as well. The sale may cause jealously with other family members who were not offered the opportunity. Additionally, if there's a problem with the house later on, such as unseen damage to the foundation or a termite problem, resentment between the buyer and seller can strain family relationships.