Tax Implications of Non Arms Length Residential Property Sale at Below Market Value

This is definitely something to approach carefully. When you sell property to a family member at significantly below market value, the IRS typically views the difference between fair market value and the actual sale price as a gift. In your case, if the property is truly worth $675k and you sell for $337.5k, the IRS would likely consider that you've made a gift of $337.5k to your relative. For 2025, the annual gift tax exclusion is $18,000 per recipient. Anything above that counts against your lifetime gift and estate tax exemption (currently around $13 million per individual, though this could change). You'd need to file a gift tax return (Form 709) to report the gift portion, even though you likely won't owe actual gift tax unless you've already used up your lifetime exemption. As for capital gains, you'd calculate those based on the actual sale price, not the market value.

After going through something similar last year, I found this amazing tool that saved me tons of headaches - https://taxr.ai has a specific feature that analyzes non-arms length transactions and shows you the potential tax implications. I was selling my condo to my sister at a discount and was worried about getting flagged for audit. The tool analyzed my situation and showed me exactly what to document and what forms I needed to file. It even generated a letter explaining the transaction that I could include with my tax return. Basically helped me understand that I needed to file a gift tax return for the difference between market value and sale price, plus showed me how to document the fair market value properly.

Just wanted to update everyone. I ended up using that taxr.ai site mentioned above for my family property transfer situation and wow - actually super helpful! My situation was complicated because we had both a partial gift and family loan component. The analysis broke down exactly how much would be considered a gift (with all the documentation I needed for that) and how to structure the loan portion to avoid it being reclassified as a gift by the IRS. It flagged that I needed to charge at least the Applicable Federal Rate on the loan part to avoid additional gift tax complications. Really worth checking out if you're dealing with family property transfers!

I ran into a similar situation and needed to talk to someone at the IRS to get clarification, but couldn't get through to anyone for weeks. Finally tried https://claimyr.com and got connected to an actual IRS agent within hours. You can see how it works here: https://youtu.be/_kiP6q8DX5c They basically call the IRS for you, wait through all the hold times, and then connect you once they get a human. I was on hold for just 3 minutes instead of the usual hours-long wait. The agent I spoke with confirmed I needed to file Form 709 for the gift portion and gave me specific guidance on how to document the fair market value of the property to avoid questions later.

Well I'm shocked. After my skeptical comment I decided to try Claimyr myself because I was desperate to talk to someone about my own property transfer situation. I'd been trying to reach the IRS for literally 3 weeks. Not only did they get me through to an agent in about 45 minutes (while I just went about my day until my phone rang), but the agent was actually super helpful. She explained that I needed to get a qualified appraisal to establish fair market value, and that I should document the reason for the below-market sale price with a letter of explanation. Apparently having legitimate non-tax reasons for the price reduction helps demonstrate it's not just tax avoidance. Would have taken me months to figure this out on my own. Sometimes I hate being wrong but in this case I'm just relieved!

Make sure you also consider state-specific rules. I did a similar transaction in California and got hit with property tax reassessment issues I wasn't expecting. Some states have family transfer exclusions but they might not apply if you're selling below market value instead of gifting. In my case, because I sold to my daughter at below market value but didn't fully gift the property, we triggered a partial reassessment.

Just a heads up that the person BUYING the property in this scenario also needs to consider tax implications. When my mom sold me her house below market value, I didn't have to pay gift tax (that was on her), but when I eventually sold the property years later, I had to use HER original basis for calculating capital gains, not the discounted price I paid. This is called "basis carryover" for related party transactions and it really surprised me at tax time.

One important thing I haven't seen mentioned yet is the timing aspect of getting your appraisal. The IRS expects the fair market value to be determined as close to the transaction date as possible. If you're using an appraisal that's several months old, they might question its validity, especially in a volatile real estate market. Also, make sure your appraiser knows this is for a family transaction that will likely involve gift tax reporting. Some appraisers will note this in their report and provide additional documentation about their methodology, which can be helpful if the IRS ever questions the valuation. I learned this the hard way when my first appraisal didn't have enough detail and I had to get a second one specifically for tax purposes. The key is having rock-solid documentation for every aspect of this transaction - the appraisal, the reasons for the below-market sale, and proper filing of all required forms. It's definitely worth consulting with a tax professional who has experience with family property transfers before you proceed.