Parents can legally sell property to a child below market value, and the IRS handles the transaction in two pieces: the price the child pays is treated as a sale, and the discount off fair market value is treated as a gift. That split drives everything else, from whether a gift tax return gets filed, to how much capital gains the parent owes, to the basis the child inherits for a future sale. Most families won’t owe any actual gift tax, but the paperwork and the second-order consequences, especially around Medicaid and property taxes, can matter more than the tax bill itself.
How the IRS Splits a Bargain Sale
Federal tax law calls a below-market family sale a “bargain sale.” The gap between fair market value and the actual sale price is a gift; the sale price is a sale.1Office of the Law Revision Counsel. 26 USC 2512 – Valuation of Gifts
Take a home appraised at $400,000 that parents sell to their child for $300,000. The parents have made a $100,000 gift and a $300,000 sale. The gift number drives gift tax reporting. The sale number drives capital gains. Each piece follows its own rules, which is why these transactions need more planning than a straight market sale.
Gift Tax: Reporting Almost Always, Paying Almost Never
The gift portion rarely produces an actual tax bill, but it often produces a filing requirement. In 2026, each person can give up to $19,000 per recipient with no reporting at all. A married couple can combine exclusions and shelter $38,000 per recipient.2Internal Revenue Service. Gifts and Inheritances
When the gift portion exceeds those thresholds, the parents file IRS Form 709 by April 15 of the year after the sale.3Internal Revenue Service. Instructions for Form 709 Filing doesn’t mean paying. Form 709 documents how much of the parent’s lifetime gift and estate tax exemption has been used. That exemption is $15 million per person in 2026, up from $13.99 million in 2025.4Internal Revenue Service. What’s New – Estate and Gift Tax Unless a parent has already given away tens of millions of dollars over their lifetime, no gift tax is due.
In the $400,000-for-$300,000 example, married parents net out to a $62,000 reportable gift after their combined $38,000 annual exclusion. That $62,000 comes off the lifetime exemption. No check to the IRS, just the return.
Capital Gains on the Sale Portion
The sale portion can trigger capital gains for the parent. Gain is the sale price minus the parent’s adjusted basis. Basis starts with what the parent originally paid and grows with the cost of capital improvements over the years.5Internal Revenue Service. Property (Basis, Sale of Home, etc.) 3
Improvements that add value or extend useful life count: additions, a new roof, updated plumbing, central air, a kitchen remodel. Routine maintenance and repairs generally don’t count unless done as part of a larger renovation.6Internal Revenue Service. Publication 523 – Selling Your Home Parents who have owned a home for decades should pull records of every major project. Each documented dollar raises basis and shrinks the taxable gain.
The Primary Residence Exclusion Still Applies
A parent who has owned and lived in the home as a primary residence for at least two of the five years before the sale can exclude up to $250,000 of gain, or $500,000 for a married couple filing jointly.7Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence The exclusion applies in a family sale the same way it applies to any other. Combined with an increased basis from improvements, it wipes out capital gains for most parents even when a home has appreciated dramatically.
Losses Between Parent and Child Are Not Deductible
If the parent’s adjusted basis is higher than the sale price, the math shows a loss. It isn’t deductible. Federal law disallows loss deductions on sales between related parties, and parent and child are related for this purpose.8Office of the Law Revision Counsel. 26 US Code 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Persons Families in markets where values have dipped often miss this.
What the Child’s Basis Becomes
The child’s cost basis controls their capital gains tax if they later sell. In a bargain sale, the child’s basis is the greater of the price they actually paid or the parent’s adjusted basis at the time of the transfer.9eCFR. 26 CFR 1.1015-4 – Transfers in Part a Gift and in Part a Sale
For long-held homes that have appreciated, the child’s basis usually equals the price paid, because the parent’s original cost is lower. If the parent bought recently or at a high price, the parent’s higher basis carries over instead. Either way, the child does not get a basis equal to the home’s full market value.
Selling Now Versus Inheriting Later
A child who inherits property after a parent’s death receives a stepped-up basis: the property’s basis resets to fair market value on the date of death, erasing appreciation that built up during the parent’s lifetime. A child who inherits a $400,000 home the parent bought for $100,000 gets a $400,000 basis and owes no capital gains if they turn around and sell at that price.
A child who buys the same home in a bargain sale at $300,000 gets a $300,000 basis. Sell later at $400,000, and $100,000 of gain is taxable. That can easily mean $15,000 to $25,000 in federal tax depending on the child’s bracket. When the parent doesn’t need the cash from a sale right now, the numbers often favor waiting.
Financing a Family Purchase
The transaction still needs to close like any other real estate deal. The child needs cash, a mortgage, or both, and lenders apply extra scrutiny when buyer and seller are related.
Lender Underwriting
A parent-to-child sale is a non-arm’s-length transaction, and underwriters look harder for inflated appraisals, fraud, and undisclosed side deals.10Fannie Mae. Purchase Transactions The child provides the same income, credit, and asset documentation any buyer would. Some programs impose tighter rules for family transactions. FHA, for example, may require a larger down payment than the standard 3.5%.
Gift of Equity as the Down Payment
One real advantage of buying from a parent is a gift of equity. The gap between appraised value and sale price can count as the child’s down payment. In the $400,000-for-$300,000 example, the $100,000 gift of equity clears a 20% down payment threshold, and the child finances only the $300,000 sale price without bringing cash for the down payment.11Fannie Mae. B3-4.3-05 – Gifts of Equity Fannie Mae allows gifts of equity on primary residences and second homes and permits them to cover the down payment and closing costs. The lender will require a signed gift letter, and the settlement statement must show the equity gift. Undocumented, the gift of equity can stall or kill the loan.
Seller Financing and the AFR Trap
Some parents prefer to act as the lender, letting the child pay them directly. Seller financing offers flexibility no bank will match, and it carries a tax trap. If the parent charges less than the IRS’s Applicable Federal Rate, the shortfall is treated as an additional gift, and the parent is also taxed on “imputed interest” they never actually received.12Office of the Law Revision Counsel. 26 US Code 7872 – Treatment of Loans With Below-Market Interest Rates The AFR changes monthly. For April 2026, the long-term rate covering loans over nine years was 4.62% compounded annually.13Internal Revenue Service. Revenue Ruling 2026-7 – Applicable Federal Rates for April 2026 Check the current month before setting terms.
The loan needs a written promissory note covering amount, rate, repayment schedule, and default. Without formal documentation, the IRS can reclassify the whole transaction as a gift.
Medicaid Look-Back Risk
Families focused on income tax often miss the Medicaid problem, and it can do the most damage. When a parent applies for Medicaid long-term care benefits, the state reviews all asset transfers made in the previous 60 months. A below-market sale sits squarely inside that review. The discount is treated the same as giving assets away and can trigger a penalty period during which the parent is ineligible for Medicaid-covered nursing home care.
The penalty length depends on the size of the discount and the state’s average nursing home cost. A $100,000 discount in a state averaging $10,000 per month works out to roughly 10 months of ineligibility. There is no cap on how long the penalty can run. If the parent needs long-term care within five years of the sale, the family can be looking at tens of thousands in out-of-pocket costs Medicaid would otherwise have covered. Parents in their 70s, or with health conditions pointing toward possible long-term care, should talk to an elder law attorney before proceeding.
Property Tax Reassessment
Transferring property to a child can trigger a reassessment for property tax purposes. In many jurisdictions the county assessor updates the assessed value to current market value, and the child’s annual property tax bill jumps well above what the parent was paying. A handful of states offer parent-to-child exclusions that let the child keep the parent’s lower assessed value, usually conditioned on the child using the property as a primary residence and filing specific forms. Rules vary by state and often by county, so check with the local assessor before closing.
Making the Transfer Real
The sale needs the same legal formality as any arm’s-length deal. “It’s family” is how disputes, title problems, and tax messes happen years later.
An independent appraisal fixes fair market value, which is the number that determines the size of the gift, the lender’s loan-to-value ratio, and the figures on Form 709. The appraiser should follow the Uniform Standards of Professional Appraisal Practice.14Internal Revenue Service. Publication 561 – Determining the Value of Donated Property A professional appraisal is the family’s best defense if the IRS ever questions the gift valuation.
A written purchase agreement should spell out sale price, any gifted equity, contingencies, and closing timeline. A title search confirms the parent holds clear title, and the child should buy a new owner’s title insurance policy, because the parent’s policy doesn’t transfer. The deed is signed, delivered, and recorded with the county; until recording, the transfer isn’t effective against third parties. Recording fees are usually modest, but some states and localities also charge transfer taxes that can be a flat fee or a percentage of the sale price.
When the gift portion is large or the parent has significant assets, the cost of a real estate attorney and a tax advisor is small next to the tax and Medicaid mistakes a poorly structured family sale can produce.