Can You Sell Your House for Less Than Its Worth?

Selling a house for less than its perceived market value is a transaction that often prompts questions about its feasibility and implications. While individuals possess the autonomy to determine the sale price of their property, such a decision introduces various financial and legal considerations. Understanding these nuances is important for both the seller and the buyer to navigate the process effectively.

Understanding Fair Market Value and Permissibility

Fair Market Value (FMV) in real estate represents the price at which a property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts. This value serves as an important benchmark for taxation, financial reporting, and legal purposes, reflecting an objective assessment based on current market conditions and comparable sales.

From a transactional perspective, individuals retain the right to sell their property at any price mutually agreed upon with a buyer. However, the nature of the relationship between the buyer and seller significantly influences how such a transaction is viewed.

Transactions between unrelated parties, known as “arm’s length transactions,” are presumed to occur at fair market value. This presumption arises because both parties are expected to act in their own best financial interest. Conversely, “non-arm’s length transactions” involve related parties, such as family members or close associates. These sales often undergo greater scrutiny because the relationship might influence the sale price, potentially leading to a price below FMV.

When a property is sold below its FMV in a non-arm’s length transaction, it introduces complexities beyond a simple purchase agreement. Such sales are permissible, but the difference between FMV and sale price may be treated differently for tax purposes, warranting careful consideration.

Tax Implications for Sellers and Buyers

Selling a property below its fair market value carries distinct tax implications for both the seller and the buyer, primarily revolving around capital gains, gift taxes, and cost basis adjustments. For the seller, if the sale price is above their adjusted basis but still below the fair market value, they would report a capital gain on the difference between the sale price and their basis. However, if a personal residence is sold for a price below both its fair market value and the seller’s adjusted basis, the Internal Revenue Service (IRS) classifies any resulting loss as non-deductible.

An important consideration for the seller in a below-market sale, especially in non-arm’s length transactions, is the potential for gift tax implications. When a property is sold for less than its fair market value, the difference between the FMV and the actual sale price may be considered a taxable gift from the seller to the buyer, potentially triggering reporting requirements or tax liabilities for the donor.

The IRS provides an annual gift tax exclusion, which for 2024 is $18,000 per recipient. A donor can gift up to this amount to any individual each year without incurring gift tax or filing Form 709. If the gifted amount (the difference between FMV and sale price) exceeds this annual exclusion, the donor must file Form 709. The amount exceeding the annual exclusion then reduces the donor’s lifetime gift and estate tax exemption.

For 2024, the lifetime gift and estate tax exemption is $13.61 million per individual. Gifts exceeding the annual exclusion reduce this lifetime exemption, but gift tax is not due until cumulative lifetime gifts surpass this amount. Spouses can also elect to split gifts, effectively doubling the annual exclusion per recipient, allowing for larger tax-free transfers. Proper valuation of the gifted component is important to accurately determine the amount of the gift for tax purposes.

For the buyer, a below-market purchase influences their cost basis in the property, which is important for determining future capital gains or losses upon resale. If a portion of the purchase is deemed a gift, the buyer’s basis may be subject to “split basis” rules.

Under these rules, the buyer’s basis for determining a future gain is the donor’s adjusted basis. However, for determining a future loss, the buyer’s basis is the lesser of the donor’s adjusted basis or the property’s fair market value at the time of the gift. This split basis approach means the buyer might face a higher capital gain or a disallowed loss when they eventually sell the property, depending on the sale price relative to these two basis figures. While direct income tax implications for the buyer from receiving a gift are minimal due to gift tax exclusions and exemptions, the adjusted cost basis impacts their future tax liability.

Key Practical Considerations for Below-Market Sales

Executing a sale below market value requires careful attention to several practical considerations beyond the immediate transaction, particularly concerning valuation, documentation, financing, and property taxes. Obtaining an independent, professional appraisal is an important step for both the seller and the buyer in a below-market sale. This appraisal establishes a credible fair market value for the property at the time of the transaction, which is important for substantiating the terms of the sale to tax authorities.

Thorough documentation of the sale terms is equally important, including any explicit intent to make a gift. Consulting with legal and tax professionals, such as real estate attorneys and certified public accountants, is advisable to ensure the transaction is properly structured and reported in compliance with federal and state laws, including specific reporting requirements like filing Form 709.

If the buyer requires financing, lender perspectives introduce complexity. Lenders base loan amounts on the appraised value, not the lower sale price. If the sale price is below the appraised value, the loan amount will still be tied to the higher appraised value, potentially requiring a larger down payment. Lenders are concerned with the collateral value, ensuring their investment is secured against its true market worth.

Property tax implications also warrant consideration, as local taxing authorities assess property taxes based on the fair market value. While a sale price below FMV might prompt a review, assessors have mechanisms to prevent artificial reductions in assessed value based on non-arm’s length transactions. They may continue to assess the property based on comparable sales and their own valuation models, meaning the buyer could still be liable for property taxes based on a higher perceived market value. The sale price does not automatically dictate a reduction in assessed value for property tax purposes.