Buying a House From Your Parents in 7 Steps
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Summary:
Buying a house from your parents can be a good way to save money on a home purchase while also providing your parents with financial support. However, the process of buying a house from family members potentially comes with a few legal tangles, so be sure to consult with a real estate attorney before closing on the sale.
Buying your parents’ house may seem like the hack of a lifetime. There are multiple upsides to buying a house from parents: you can save money on down payments and closing costs, you don’t need to worry about hiring a real estate agent, and you get to keep the childhood home you loved growing up in. Best of all, having an established relationship with the sellers can make the entire home-buying process much less stressful.
However, just because you already know the sellers doesn’t mean the process will involve less work. There are multiple legal aspects to consider, such as the terms of the mortgage and the potential tax implications of buying a house from a family member. If you opt to forgo a real estate agent, it will be up to both you and your parents to handle all that paperwork and legal research.
Read on for an in-depth overview of everything you need to know about buying a house from your parents, including a step-by-step guide and the reasons why it may or may not be worth the investment.
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Why buying a house from parents can be a good idea
Whether you’re trying to help out your parents or you’re acting in your own self-interest, chances are you’ve already given some thought to the financial impact of buying your parents’ house. The following are some of the advantages that come with buying a home from family members:
Save money
The most obvious upside of buying a house from your parents is that it can save you money on a home purchase. Typically, buying your parents’ home is easier and less expensive than buying a house from a stranger. Closing costs are often lower, and if you don’t use a real estate agent, you can avoid paying as much as 6% of the purchase price in commissions.
Another advantage of buying a house from family members is that you might receive a gift of equity. This is when a friend or family member sells you a property at a price below the current market value. In many cases, a mortgage lender will allow the cash gift to count as a down payment on the home.
The following are the requirements you must meet in order to receive a gift of equity:
- The seller must complete an appraisal on the home. This is a written document stating how much a property is worth.
- The document must note the appraised value along with the sales price of the home.
- Both parties involved must complete the gift equity paperwork, which includes the understanding that the gift does not need to be paid back.
- While closing the sale, you must submit a settlement letter that mentions the gift.
Support your parents in retirement
Another reason you might want to buy your parents’ home is to support them financially. Maybe they’re short on retirement funds, or maybe they’re simply not able to care for their home anymore.
In this case, you might consider purchasing your parents’ home as an investment property to rent out for extra income, or you can move in with them to help them take care of the house while relieving the burden of real estate taxes from their finances. An adult child might also choose to buy their parents’ home and rent it back to them for less than the monthly payments on their existing mortgage as a way to help alleviate financial stress.
Pro Tip
Be careful not to reduce rent by too much or allow a tenant to live rent-free for too long, as that could land you in trouble with the IRS.
Sentimental value
Not all your reasons for wanting to buy a family member’s house need to be financial. Maybe your parents still live in the home you grew up in, and you want to make sure that property stays in the family. If the idea of a stranger living in your childhood home — or worse, tearing it down — doesn’t sit too well with you, buying your parents’ home can be a great way to preserve the memories attached to the house — while also building new ones with your own family.
How to buy your parents’ home
While buying a house from your parents has plenty of upsides, the process can still be a bit complicated. To make sure you have all your bases covered, follow these home-buying steps:
Step 1: Discuss expectations before you begin
Before diving into the home-buying process headfirst, it’s a good idea to take a breath and have a detailed conversation with your family members about the expectations you all have going in. Even if you are ultra-close with your family, real estate transactions don’t leave a lot of room to read between the lines.
In this step, it may be helpful to draw up a list of discussion points so you can make sure nothing is left unsaid. It’s crucial to get this out of the way now, as a major misunderstanding further down the road can lead to a highly stressful legal hassle that may strain your relationship with your family.
Here are a few examples of key points you should discuss with your parents:
- What will be the final purchase price of the house?
- Should you hire experts to help you through the sale, such as a real estate attorney or a home inspector?
- When would be the best closing date for both parties?
- Who will live in the house after the sale is final, and what will that arrangement entail?
Remember, documentation is your friend here. Once you’ve outlined all your expectations, make sure to put everything in writing. That way, you’ll have a clear record of the agreement to which you can all refer throughout the rest of the home-buying process.
Step 2: Educate yourself on non-arm’s length transactions
Because you’re buying a house from family members, it’s important to understand what a non-arm’s length transaction is. According to real estate expert Ryan Zomorodi of Real Estate Skills,
“A non-arm’s length transaction occurs when the buyer and seller have a pre-existing relationship, such as being related by blood or marriage. This type of transaction is subject to different rules and regulations than arm’s length transactions.”
Mixing family and business can easily blur the lines between both parties’ interests, which has possible legal implications due to the increased chance of fraud.
According to the Internal Revenue Service (IRS), in principle, a real estate transaction must meet the arm’s length standard — in other words, the purchase price of your parents’ home must be comparable to that of a deal made between strangers. Before you buy your parents’ house, make sure you familiarize yourself with the ins and outs of non-arm’s length transactions so you can avoid running into legal trouble.
Step 3: Be prepared for potential tax implications and restrictions
Because non-arm’s length transactions carry a higher risk of fraud, you may face some restrictions while trying to buy your parents’ house.
To start off, you may be required to put down a minimum down payment — for example, in order to be approved for an FHA loan, your down payment must be equal to at least 15% of the purchase price. There are a few exceptions to this rule that can reduce your down payment, such as if you’re purchasing the primary residence of a relative, fiancé, or domestic partner, or if you’re purchasing a property from a landlord or a family member from whom you’ve rented for the six months prior to the purchase agreement.
There are also tax limitations to consider. For instance, a gift of equity has a limit on how much can be gifted. As of 2023, in the U.S., the maximum limit for a gift is $17,000 per individual. If the difference between the market value and the sale price of the house exceeds this amount, your parents will need to file a gift tax form. However, you don’t actually need to pay any tax on it until your combined lifetime gifts (in excess of the annual exclusion) exceed the lifetime gift tax exclusion, which is $12.92 million as of 2023.
Pro Tip
If all these legal and tax hoops seem like too many for you to jump through on your own, don’t be afraid to pass the legal obligation of the home-buying process off to a tax professional. A real estate attorney is well worth the investment, as they can protect you from tax mistakes and help save you a lot of money down the line.
Step 4: Know the standing of your parents’ mortgage
As you proceed with buying their home, it’s important to get a clear picture of your parents’ current financial situation. Are they still making mortgage payments, or do they fully own the house? If they’re still paying off the home, are their monthly mortgage payments up to date? What financial institution is lending them the home loan?
The status of your parents’ mortgage will determine your options for buying their house. If your parents fully own the home, you can purchase it with cash or take out a new mortgage. In the case of an assumable mortgage, you can take over the home loan from your parents and continue the monthly payments from where they left off.
If your parents have a mortgage that is not assumable, you can contact the mortgage lender to request a transfer, but you may need to start from scratch on a new mortgage. Before contacting the lender, be sure to have a good understanding of their policies regarding real estate transactions between family members.
Step 5: Determine the final sales price
Now for the moment you’ve been waiting for: buying your parents’ house! If you’ve been talking to your parents about buying their house for a while, you’ve probably already discussed the numbers. However, before you settle on a final sales price, here are a few important points to consider:
- What is the fair market value of the house? To determine this number, it’s worth having the house appraised by a professional.
- What are other similar homes selling for? Real estate agents are a great resource for legal counsel and opinions on pricing. If you’re not using a real estate agent, you’ll need to do your own research into what similar homes are selling for. Remember that the market fluctuates, so make sure you research homes that are on the market at the same time you plan to buy your parents’ house.
- Is there an equity gift involved, and if so, how big will the discount be? Keep in mind that the IRS may intervene in the home purchase if the sales price of the house is too far below market value.
Step 6: Conduct a home inspection
You may think you already know your parents’ home like the back of your hand, but it’s still important to have the house inspected by a professional before you close the sale. This can help you detect any underlying issues that need to be corrected immediately, such as a mold problem or faulty wiring that can be a fire hazard. Left unchecked, these problems could end up costing you a lot of money later on, but if you catch them during the home-buying process, you can work out an agreement with your parents to resolve the issues early.
Step 7: Buy your parents’ house!
After the home inspection is complete and the purchase agreement has been drawn up, it’s time to close the sale! Contact your mortgage lender and officially apply for a home loan. Once you and your parents have all signed the paperwork, it’s official: you’ve bought your parents’ house!
Keep in mind that even after the sale is closed, the IRS can look into your case at any time. Of course, this shouldn’t be a problem as long as you’ve made sure to meet the arm’s length standard throughout your real estate transaction.
FAQ
Can my parents sell me their house for a cheap price?
While there is a limit to how much they can lower the purchase price, your parents can sell you their home for less than average by reducing the down payment and closing costs.
What are the tax implications of buying my parents’ house?
If you purchase your parents’ home while they’re still alive, you may need to pay capital gains tax on the sale. However, if you buy the house after they pass away, you may be able to avoid these taxes altogether.
Can I buy my mom’s house for a dollar?
Unfortunately, you cannot buy your mom’s house for a dollar; if the sales price of a home is too far below market value, you may run into trouble with the IRS.
How do I buy an elderly parent’s house?
Buying your elderly parent’s home involves many of the same steps as a traditional home sale, including settling on a purchase price, conducting a home inspection, and drawing up a purchase agreement. However, because you’re buying a home from a family member, it helps to make sure you are fully informed about the possible tax restrictions of a non-arm’s length transaction before beginning the home-buying process.
Can I sell my parents’ house on their behalf?
It is possible to sell your parents’ home on their behalf. However, you will need permission from the court to do so, even if you are your parents’ legal guardian.
Key Takeaways
- There are multiple benefits to buying your parents’ house, such as saving money, reducing the stress of the home-buying process, supporting your parents in retirement, and maintaining the sentimental value attached to your childhood home.
- Buying a house from your parents can be less expensive due to a reduced down payment, lower closing costs, and the chance to forgo hiring real estate agents. You may also receive a gift of equity if your parents choose to sell you their home for a price below its fair market value.
- Buying a home from parents or other family members constitutes a non-arm’s length transaction, which carries a higher risk of fraud. Because of this, you may face a number of restrictions when trying to buy your parents’ home.
- Before you begin the home-buying process, make sure to openly discuss expectations with your parents and keep a written record that you can all refer to until you close the sale.
- The home loan type will determine if you can take over your parents’ existing mortgage or if you will need to take out a new mortgage. If your parents fully own their home, you can also buy it from them with cash.
Whether you’re buying a house from your parents or from a stranger, the home-buying process may often feel overwhelming. If you’re in the market for your first home, SuperMoney can help you make the process as easy as possible. Start by checking out our first-time home buyer guide, then use our comparison tool to find the best home loans for you!
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