Buying a home from a family member is a way to secure ownership of a property that is familiar to you, perhaps at an attractive price. However, while buying a home from family members may seem easy, the process can be full of pitfalls that can lead to unwanted attention, particularly from the Internal Revenue Service.
Non Arms-Length Transaction
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A real estate transaction between two people who do not know each other is called an arms-length transaction. The term implies distance or separation between the buyer and seller.
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A transaction between family members would be considered a non arms length transaction. People who know each other have more potential to collude to commit fraud, and mortgage lenders and the IRS take a close look at these transactions. For example, if a seller is upside-down on their mortgage and wants to sell to a family member for less than what he owes in a short sale, the mortgage holder will ensure that the house is selling for close to its present market value, so that the buyer is not profiting at its expense.
Tip
Have an accurate appraisal of any family real estate transaction to establish market value, not only with a short sale, but also for potential tax ramifications.
Mortgage Financing
While conventional mortgages do not have specific requirements concerning a home purchased from a family member, Federal Housing Authority insured loans require some additional disclosures. You must complete an Identity of Interest Certification, disclosing the relationship you have with the seller. Buying from a relative will only allow you to qualify for an FHA mortgage of 85 percent of the purchase price, unless you are buying a family member's primary residence or have been renting the house for at least six months.
Warning
It is a federal crime to purchase a home from a family member, finance that purchase with an FHA loan, and not disclose the relationship.
Using a Broker and Lawyer
When buying a house from a family member, a broker may not be necessary. Advertising and marketing are not needed, and negotiations can take place between the buyer and seller directly. However, a broker can offer pre-written contracts and offer forms, and help with some expertise on the local market. Negotiate a discounted commission or a flat fee if you use a broker with a family purchase. Contracts for purchase also can be written by the closing attorney. You also may feel the need to consult with a lawyer to protect your interests and ensure that you are not being taken advantage of.
Receiving a Gift
A home given as a gift from a family member may have tax implications. IRS gift tax regulations limit the value of any gift that a person can give without incurring gift taxes. If the purchase price of a home by a family member is less than market value, the IRS will consider it a gift. A lawyer qualified in estate planning can reduce or eliminate the tax consequences with proper planning. A seller-financed mortgage from a family member at a reduced rate also will trigger gift tax consequences.
Type of Deed
The deed is the document that passes property from one party to another. With most home sales, a warranty deed is used, which says that the seller transfers title and guarantees that he owns the home free and clear of all liens. It generally is backed up by a title insurance policy, which will pay off any hidden liens that may appear later.
A quit claim deed states that the seller is transferring any interest he has to the other party, but does not guarantee that he owns the property free and clear of liens. The quit claim has less security, but is used more often with family members when a home is transferred rather than sold, or when a mortgage is not necessary.