Non Arms Length Residential Property Sale - Tax Implications when Selling Below Market Value

This is what's called a "non-arms-length transaction" because you and the buyer have a relationship. The IRS definitely pays attention to these! When you sell property significantly below market value to a relative, the difference between fair market value and the sale price ($250,000 in your case) is considered a gift for tax purposes. For you as the seller: You might need to file a gift tax return (Form 709) for the $250,000 "gift" portion. However, you likely won't actually owe gift tax because of the lifetime gift and estate tax exemption, which is over $12 million per person in 2025. You'll just need to report it and it counts against your lifetime exemption. For the buyer: They get a bargain, but their cost basis in the property will be the $240,000 they paid plus the $250,000 gift amount. This matters when they eventually sell, as their capital gains will be calculated from this full basis. Make sure you have a proper appraisal done to document the fair market value at the time of sale. Both parties should consult with tax professionals before finalizing this kind of transaction.

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After dealing with a similar non-arms-length transaction last year, I can tell you the most frustrating part was trying to get answers from the IRS. I spent WEEKS trying to get through to someone who could answer my specific questions about how to properly report everything. Finally found this service called Claimyr (https://claimyr.com) that got me through to an actual IRS agent in less than an hour! They have this demo video that shows how it works: https://youtu.be/_kiP6q8DX5c The agent confirmed that I needed to file Form 709 for the gift portion but also explained some special rules about related-party sales that weren't clear from just reading online. Having that official guidance saved me from making what could have been a costly mistake on my return. Definitely worth it when you're dealing with complex tax situations like property transfers between family members.

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Something nobody's mentioned yet - if you sell property below market value, your local property tax authority might still assess transfer taxes based on the market value, not your actual sale price. In my county, they automatically flag transactions that are more than 15% below recent comparable sales for review. Also, if the buyer gets a mortgage, the lender might require a special review process for non-arms-length transactions to prevent fraud. Just something to keep in mind!

Has anyone actually gone through an IRS audit because of a below-market family property sale? I keep hearing horror stories but wondering if that's just tax professionals being extra cautious.

This is a really important question, and I'm glad you're thinking ahead about the tax implications! As others have mentioned, selling significantly below market value to a family member does trigger gift tax reporting requirements. One thing I'd add that hasn't been covered yet - make sure you get a qualified appraisal done by a certified appraiser, not just a real estate agent's market analysis. The IRS requires a qualified appraisal for gift tax purposes when the gift portion exceeds $5,000. In your case with a $250,000 difference, this is definitely required. Also, consider the timing of the sale. If you've lived in the house as your primary residence for at least 2 of the last 5 years, you might be able to exclude up to $250,000 of capital gains from your income (or $500,000 if married filing jointly). This could affect how you want to structure the transaction. The key is proper documentation and filing the right forms. Don't let the complexity scare you away from the transaction if it makes sense for your family, but definitely consult with a tax professional who has experience with family real estate transfers before you proceed.