Buying a house from a family member works like any other home purchase on paper: appraisal, contract, mortgage, closing. What changes is that the IRS and mortgage lenders treat the deal as non-arm’s length, which brings extra documentation, tighter loan rules, and tax consequences that don’t show up in a normal sale. Most of the friction comes from one fact: relatives often sell to each other at a discount, and every party to the transaction — the lender, the IRS, and potentially Medicaid — wants to see that discount handled correctly.
Get an Independent Appraisal First
Before anyone agrees on a price, hire a state-certified or licensed appraiser. Federal regulations require one for federally related residential transactions, and your lender will insist on it regardless of how well the parties know the property.1eCFR. 12 CFR 34.43 – Appraisals Required; Transactions Requiring a State Certified or Licensed Appraiser A single-family appraisal typically costs a few hundred dollars.
The appraised value is the number every later step keys off. It sets how much equity the seller is giving up if the sale price is lower, how much the lender will finance, and whether the discount triggers gift tax reporting. Without it, you have no defensible fair market value to show the IRS or the mortgage company.
The Gift of Equity
When a relative sells you the home for less than the appraised value, the shortfall is called a gift of equity. If the home appraises at $300,000 and your relative sells it to you for $220,000, the $80,000 difference is the gift. Lenders typically let this 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 loan that would blow up your debt-to-income ratio. Both sides should also have bank statements ready, because lenders scrutinize the flow of funds in family sales more closely than they would in an ordinary purchase.
Gift Tax Reporting for the Seller
A gift of equity at or below $19,000 — the federal annual gift tax exclusion for 2026 — requires no filing.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 If the seller and their spouse both own the home, each can gift $19,000 to the buyer, effectively doubling the exclusion to $38,000.
Above that, the seller must file IRS Form 709.4Office of the Law Revision Counsel. 26 U.S.C. 2503 – Taxable Gifts Filing does not usually mean paying. The excess counts against the seller’s lifetime gift and estate tax exclusion, which is $15,000,000 for 2026, and no actual gift tax is owed until cumulative lifetime gifts exceed that threshold.5Internal Revenue Service. What’s New – Estate and Gift Tax Very few family home sales generate a gift tax bill, but the reporting requirement is mandatory whenever the annual exclusion is exceeded.
Mortgage Rules Are Stricter in Family Sales
Lenders apply tighter rules to family sales because the pre-existing relationship creates a risk that the price and terms don’t reflect a real market transaction. The specifics depend on your loan type.
FHA Loans
The FHA caps the loan-to-value ratio at 85 percent for identity-of-interest transactions, which includes any sale between family members.6HUD. FHA Single Family Housing Policy Handbook You need at least 15 percent equity, far more than the standard 3.5 percent FHA minimum. A gift of equity can satisfy this.
Two situations waive the 85 percent cap:
- You’re buying the seller’s principal residence and plan to occupy it as your own. Standard FHA LTV limits apply instead.
- You’ve been renting the home for at least six months before signing the sales contract. You’ll need a lease or written proof of tenancy.
Conventional Loans
Fannie Mae allows non-arm’s-length transactions on existing properties without a blanket LTV cap like the FHA imposes.7Fannie Mae. Purchase Transactions Your lender will still verify that the transaction is legitimate, that you intend to occupy the home as a primary residence, and that the gift-of-equity paperwork is clean. Individual lenders can layer their own overlays on top.
Occupancy
Both FHA and conventional lenders generally require the buyer to occupy the home as a primary residence. For FHA, at least one borrower must move in within 60 days of closing. Buying a family member’s property as an investment or second home shrinks your financing options considerably and can bring stricter identity-of-interest treatment.
Seller Financing and Imputed Interest
Some families skip the bank and have the seller finance the purchase directly through a private mortgage or installment agreement. This is workable, but the IRS requires the loan to carry at least the applicable federal rate, published monthly. If the loan’s interest rate falls below that rate, the IRS treats the loan as if interest were being charged at the AFR anyway — 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 consequence lands on the seller: they must report the imputed interest as income even if they never collected it. Check the current month’s AFRs before setting your rate.9Internal Revenue Service. Applicable Federal Rates A zero-interest family loan is a fast way to hand the seller an unexpected tax bill.
Put It in Writing: Contract and Disclosures
Trust between relatives doesn’t remove the need for a written purchase agreement. Any mortgage lender will require one, and it protects both sides if something later goes sideways. Standard residential purchase contracts are available through real estate attorneys, legal form providers, and local bar associations. The contract should state the purchase price and the gift of equity amount if the price is below fair market value, include inspection and financing contingencies, list any appliances or fixtures that stay with the home, and carry the exact legal description from the current deed.
Disclosures still apply. If the home was built before 1978, federal law requires the seller to provide a lead-based paint disclosure and the EPA lead hazard pamphlet before you’re bound by the contract, 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 Knowingly skipping that disclosure can expose the seller to civil penalties and up to three times the buyer’s damages. Most jurisdictions also require the seller to disclose known material defects such as foundation issues, roof leaks, or past flooding. The family relationship creates no exemption.
Tax Consequences You’ll Both Care About
The Seller’s Capital Gains Exclusion
A seller who has owned and lived in the home as a primary residence for at least two of the last five years can exclude up to $250,000 in capital gains from income, or $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 the same as any other, but it can only be used once every two years.
Your Cost Basis as the Buyer
Buying at a discount from a relative affects your future tax bill through cost basis, the starting point for calculating capital gains when you eventually sell. In a bargain sale where you pay some amount and 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 is transferred entirely as a gift with no payment, your basis is typically the donor’s adjusted basis rather than the current market value.13Internal Revenue Service. Property (Basis, Sale of Home, Etc.)
A lower basis means a larger taxable gain later. If your parent bought the home for $120,000, sells to you for $200,000 when it’s worth $350,000, and 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 offset much of that gain, but on higher-value homes the basis gap still bites.
Medicaid Look-Back if the Seller Is Older
If the family member selling you the home is older or may need long-term care within the next five years, a below-market sale can create a Medicaid problem. Federal law requires states to review asset transfers made within 60 months before a person 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 finds the seller transferred assets for less than fair market value during that window, it imposes a penalty period of Medicaid ineligibility for long-term care.15CMS. Transfer of Assets in the Medicaid Program
The penalty length is the uncompensated transfer 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. Selling at full appraised value is the safest route. If a discounted sale matters to both parties, talk to an elder law attorney before you sign anything.
Don’t Try to Skip the Mortgage Payoff
If the seller still has a mortgage, it almost certainly contains a due-on-sale clause letting the lender demand full repayment when ownership changes. In a normal family sale where you get a new mortgage, this is a non-issue — the seller’s loan gets paid off from the proceeds at closing.
The trap is trying to transfer ownership informally by adding you to the deed or using a quitclaim while the seller’s mortgage is still in place. Federal law blocks lenders from enforcing due-on-sale 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 Transfers to siblings, parents, cousins, aunts, uncles, and other extended relatives are not protected. Outside the protected categories, the lender can call the full balance due.
Closing, Recording, and Transfer Taxes
Once the contract is signed and financing is in place, a title company or escrow agent handles the closing. They run a title search, issue title insurance, collect your funds, pay off the seller’s existing mortgage, and distribute the remaining proceeds. Both parties sign the mortgage documents and deed in front of a notary, and the title agent submits the deed to the county recorder.
Budget for transfer taxes, which many jurisdictions charge as a percentage of the sale price. Rules vary: some jurisdictions exempt family transfers entirely, others apply the full rate regardless of relationship. Ask your title company or a local real estate attorney what applies where the property sits before you get to the closing table.