Selling a home to a family member for $1 or another nominal amount may seem like a clever way to avoid paying inheritance tax. However, the IRS has rules in place to prevent tax avoidance through below-market-value sales. Here is an overview of inheritance tax and how home sales between relatives are treated for tax purposes.
What is the Inheritance Tax?
The federal inheritance tax, also known as the estate tax, is a tax imposed on the transfer of property from a deceased person’s estate. It only applies to very large estates – for 2023, it kicks in for estates valued over $12.92 million.
For estates under this threshold, no federal tax is owed. However, some states have separate inheritance taxes that apply at much lower exemption amounts.
How Are Below-Market Home Sales Taxed?
If you sell your home to a family member for $1, the IRS will not accept that sales price at face value. Below-market sales are recharacterized as part gift and part sale.
Specifically, if the home’s fair market value is significantly higher than the sales price, the difference is considered a gift. This gift value would count towards the lifetime federal gift and estate tax exclusion amount ($12.92 million in 2023). You would need to file a federal gift tax return in the year of the sale.
Additionally, your son would not acquire the home with a cost basis of $1. The cost basis would be adjusted upward to account for the gift element. This would limit the capital gains tax savings when the home is eventually sold.
What About State Inheritance Taxes?
Even if a below-market sale escapes federal gift and estate tax, it could still create state inheritance tax liability. Many states impose tax on inheritances that exceed an exemption amount ranging from $1 million to $5 million.
For example, say you live in a state with a $2 million inheritance tax exemption. If the fair market value of the home is $1.5 million, but you sell it to your son for $1, the remaining $1.49 million could be taxable.
Structuring the sale as a part gift/part sale for federal purposes may not exempt the gift portion from state inheritance tax.
Alternative Strategies to Minimize Taxes
Rather than an outright sale to your son for $1, there are more effective ways to transfer your home while minimizing taxes:
- Sell at fair market value – This avoids gift tax and provides your son with a stepped-up cost basis.
- Transfer to a spousal lifetime access trust (SLAT) – You retain access while transferring future appreciation out of your taxable estate.
- Transfer to an irrevocable trust – Removes the home from your estate after a set term of years.
- Gift a portion of the home – $16,000 annual federal gift tax exclusion.
- Lease the home to your son at fair market rent – Gradual transfer of equity over time.
The best approach depends on your specific financial and tax situation. Consult an experienced estate planning attorney and tax professional.
What Are the Rules on Selling a Home for $1?
Here is a summary of the key rules and restrictions around selling a home to a family member for $1:
| Issue | Rules and Restrictions |
|---|---|
| Federal gift tax | The below-market value is treated as a taxable gift |
| Federal estate tax | The gift portion still counts towards your lifetime exclusion |
| Cost basis | Adjusted from $1 to account for gift element |
| State inheritance tax | Gift may still create state inheritance tax liability |
| IRC Section 1041 | Does not apply to sales between parent and child |
| Disclosures | IRS Form 709 gift tax return required |
Are There Any Exceptions to the Gift Tax Rules?
Section 1041 of the Internal Revenue Code provides an exception to the gift tax rules for certain transfers between spouses and ex-spouses. However, this exception does not apply to sales between parents and children or other family members.
The only way a below-market sale could potentially avoid gift taxes is if the seller retains a life estate in the property, or continues to live there and pay fair market rent. Even then, state inheritance tax could still apply to the remainder interest.
In general, it is very difficult to avoid IRS scrutiny of below-market intra-family home sales. The gift tax and cost basis rules provide significant obstacles to using a $1 home sale to avoid taxes.
What Else Should I Know About Home Transfers?
Here are some other key facts to understand when transferring a home to family:
- Capital gains taxes still apply when the home is later sold by your son for a gain, even with a stepped-up basis.
- Your son does not receive a step-up in basis for inherited property if capital gains taxes were already avoided through the $1 sale.
- You maintain the right to live in the home when transferring it to an irrevocable trust.
- Gifted interests are subject to a look-back period for Medicaid eligibility purposes.
- Any lifetime gifts utilize your federal gift and estate tax exclusion amount.
Consult an attorney to ensure you comply with all IRS requirements and adequately plan for taxes. With proper strategy, transfers can be minimized.
Conclusion
Selling a home to a child or other family member for a nominal $1 sales price will not achieve the intended goal of avoiding inheritance or capital gains taxes. The below-market value will be treated as a gift by the IRS and still factor into tax calculations upon your death.
Rather than a sale for $1, there are better options for transferring a home, such as an irrevocable trust, spousal lifetime access trust, or gradual gifting. Each approach carries pros and cons that must be weighed against your financial situation.
Careful advance planning, with legal and tax guidance, is key to minimize taxes on intergenerational home transfers. However, the $1 sale technique will not work to completely avoid taxation.