A father may sell his property to his son. If he sells it at a discount that exceeds $16,000 off of the value, the IRS considers that portion to be a gift, and he (the son) must report it. The IRS will deduct the difference between the selling price and fair market value from the son’s lifetime tax exemption of $12.06 million.
Selling property to a family member involves a lot of legalities because people can abuse the procedure to avoid paying federal taxes. However, it needn’t be overcomplicated, as you’ll see when we explore the costs, legalities, importance of fair market price, and utilizing estate agents.
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Can a Father Sell His Property To His Son?
The desire to keep your property within your family carries a sense of nobility and will offer your son a great boon to set up his (future) family for success. As a father in the US, no legal restrictions prevent you from selling your property to your son.
However, since it’s a non-arm’s-length transaction, you need to inform the IRS, who may classify the sale as a gift.
An arm’s length transaction consists of an unaffiliated buyer and seller, and both parties have equal haggling opportunities. They act independently, whereby the buyer wants to pay as little as possible, and the seller wants to sell for a high value.
When you sell to your son, it becomes a non-arm’s length transaction – a transaction between people who have a relationship. It is perfectly legal but it does require that you allocate taxes correctly.
It also has the potential for fraud, meaning the IRS will treat the transaction with serious scrutiny, and you may need to provide additional information or documentation. The IRS will check whether the sale price meets the prerequisites for a gift and that the price is a fair market value.
When a property sells as a gift, it affects an individual’s lifetime tax exemption – an amount that every taxpayer receives from the government for gifting assets throughout their lifetime – the exemption amount in 2022 stands at $12.06 million.
Tax Exemption: Father Selling Property to Son
You have a $16,000 tax gift exemption limit per annum and a lifetime limit of $12.06 million. Whenever you gift more than $16,000, you need to report it to the IRS, who will deduct it from your lifetime gift limit.
You may want to give your son a sizeable discount on your property, but being too generous will include additional costs from the state. Tax consequences exist when you sell far lower than the fair market value, to prevent people from abusing the system and avoiding federal estate tax when they give away their assets.
The IRS 2022 tax guidelines permit all persons to gift up to $16,000 per annum to any number of people, increasing to $32,000 for people married and filing jointly — without having to report those gifts to the IRS.
Consequently, owning a property with a value below $16,000 means you don’t need to pay tax, while anything over makes you liable for tax.
If you wanted to gift your sibling $16,000 to purchase a new vehicle, you could do so without reporting it to the IRS. However, giving $18,000 instead puts you $2,000 over the restriction, and you must report the gift to the IRS. They will deduct the $2,000 difference from your lifetime exemption of $12.06 million.
The tax exemption limit applies to gifts given while you are alive and after you pass, so it’s wise to account for inheritance plans regarding gift tax. Once you surpass the tax exemption limit, you can expect to pay a taxation rate of 18 – 40 percent.
What Happens When Sell Your Property Below Market Value?
You must report the difference between your selling price and the fair market price, minus the yearly tax-exempt figure of $16,000, to the IRS.
The same rules for gifting assets will apply when you sell your property to your son. However, instead of dealing with money, the gift will take the form of a discount on the property’s value.
The IRS will consider it a gift of equity. Remember, if the value of the gift exceeds $16,000, you must report it. You can calculate the value by the difference between your selling price and the fair market value – this is another reason why getting an appraisal is a wise decision.
If, for instance, you sell your property to your son for $300,000, but the fair market value is $450,000, you’re essentially gifting them $150,000. Then, subtract the $16,000 that you are exempt from annually, and the final value of your gift will be $134,000 – you need to report this figure to the IRS.
The IRS will subtract the $134,000 from your $12.06 million lifetime exemption limit. The difference is tiny when you look at the entire picture, but the goal of the IRS is to prevent people from abusing the system to avoid federal taxes.
Please note that the above example is for educational purposes only. You would do well to consult a certified public accountant (CPA) on tax events resulting from selling your property to your son.
Determine The Property’s Value for the Best Outcome
An appraisal is necessary because the value of your property is likely not the same as when you purchased it (unless that was very recently). You will also need to determine the fair market value of your property if your son wants a mortgage, because lenders want to know if the property’s value can match the mortgage amount.
The value of your property may not be the same as when you first got it. As such, a neutral third-party professional appraiser makes it much easier to establish a fair market value for your property.
It’s also worth considering that even if you already have an agreed selling price, an official value is still necessary if your son wants a mortgage. Lending institutions will want a guarantee that the property’s value is high enough to meet the value of the mortgage.
Your real estate agent can also analyze the market to find a suitable property value using a multiple listing service (MLS). It exists as a private database with a list of local property values. Furthermore, the MLS contains specifics about seller disclosures and property regulations.
Father Selling Property to Son: Does He Need an Agent?
An estate agent is not strictly necessary, but they can mediate between yourself and your son to keep the transaction free of contention.
A real estate agent shouldn’t be necessary to mediate between a father and son, especially if you can both come to an agreeable price. You will also save on the commission fee of having an estate agent.
However, it’s also true that money is the cause of many relationships turning south, often when you least expect it. A reputable estate agent can prevent the transaction from becoming contentious by advocating for both sides to keep the peace.
Continue Reading: Can My Father Sell His Property Without My Consent?
Conclusion
US law does not prohibit a father from selling their property to their son. The IRS only requires that, if the discount of the selling price from the fair market value is more than $16,000, they report the difference. It helps them investigate the transaction to ensure there are no signs of foul play or fraudulent activity hinting toward avoiding federal taxes.