Selling Property to Family Below Market Value: How the Part-Sale, Part-Gift Tax Rules Work
A Shahbaz & Associates guide for families transferring property below fair market value.
Selling property to a family member for less than it is truly worth is one of the most common ways one generation helps the next. What surprises many of our clients is that the IRS does not treat such a transaction as a simple sale. When the price falls below fair market value, the deal is split into two pieces: a sale and a gift. The sale side can create a capital gain, and the gift side runs through the federal gift tax system.
For 2026, the annual gift tax exclusion is $19,000 per recipient and the lifetime exemption sits at $15,000,000 per person. But the piece that trips families up most often is not the gift tax at all. It is the basis the recipient inherits, which determines what they will owe when they eventually sell.
Below, we walk through each moving part the way we would with a client across the table.
Key Takeaways
- A below-market sale to family is taxed as part sale, part gift, not as a straight sale.
- The seller pays capital gains tax only to the extent the price exceeds their adjusted basis; a loss is never deductible.
- The gift portion (fair market value minus the price) uses the 2026 $19,000 annual exclusion, with the excess applied against the $15,000,000 lifetime exemption.
- The buyer takes a "dual basis": one figure for future gain, another for future loss.
- Almost every pitfall is avoidable with planning done before the transfer closes.
How Is a Part-Sale, Part-Gift Transfer Split?
The math behind the split is refreshingly simple:
- Sale portion = whatever the buyer actually pays.
- Gift portion = the property's fair market value minus that payment.
Fair market value is the price a willing buyer and a willing seller would agree to, with neither under pressure and both reasonably informed.
Nailing down fair market value is the foundation everything else rests on. If the IRS later concludes the property was worth more than you reported, both your capital gain and your gift tax exposure climb at the same time. For real estate and other significant assets, we strongly recommend a qualified appraisal completed before the transfer closes. There is no separate appraisal mandate for family transfers the way there is for large charitable gifts, but a contemporaneous appraisal is your best protection if the valuation is ever challenged.
Income Tax for the Person Giving Up the Property
If you are transferring the property, your gain is measured by comparing the amount you received against your entire adjusted basis in the property. When the price you collect is higher than your basis, the difference is a taxable capital gain.
And if the price comes in below your basis? You might expect a deductible loss. You will not get one. The rules expressly bar recognizing a loss on a transfer that is partly a gift. The reasoning is intuitive: you chose to sell cheaply, so the shortfall reflects generosity rather than a real economic loss.
Worked Example 1: A Discounted Sale to a Child
Suppose a parent owns a rental property worth $400,000 with an adjusted basis of $150,000, and sells it to an adult child for $250,000.
- Gift portion: $400,000 fair market value minus $250,000 paid = $150,000
- Taxable gain: $250,000 received minus $150,000 basis = $100,000
- Loss: none. Even if the parent's basis had exceeded the price, the shortfall would be disallowed.
The parent reports the $100,000 gain on Schedule D for the year of the transfer. Whether long-term capital gains rates apply depends on how long the parent held the property beforehand.
Worked Example 2: Selling Property to Family "At Cost"
A scenario we see constantly: a relative wants to transfer property for exactly what they originally paid, assuming that a sale "at cost" is tax-free. Sometimes it is, and sometimes a hidden tax is lurking.
Suppose an aunt owns property now worth $400,000 that she purchased for $300,000, and she transfers it to her niece for that same $300,000.
- Her income tax. If $300,000 is her adjusted basis, her amount realized equals her basis, so her recognized gain is $0. A genuinely clean result.
- The depreciation trap. If the property has been a rental, her adjusted basis is below her $300,000 original cost because of the depreciation she has claimed over the years. Say she has deducted $50,000 of depreciation, leaving an adjusted basis of $250,000. Selling at $300,000 now produces a $50,000 gain, and for real property that entire amount is unrecaptured Section 1250 gain, taxed at rates up to 25%. A sale the family thought was tax-neutral quietly generates a recapture bill. Before any "at cost" transfer, confirm whether the number is original cost or adjusted basis.
- The gift. The gift portion is $400,000 minus $300,000, or $100,000. After the $19,000 annual exclusion, $81,000 is applied against the aunt's $15,000,000 lifetime exemption. No check goes to the IRS, since she is nowhere near exhausting the exemption, but she still must file Form 709 to report it.
- The niece's basis. Her gain basis is the greater of the price paid ($300,000) or the aunt's adjusted basis ($300,000), and her loss basis is the lesser of that figure or the $400,000 fair market value. Both collapse to a single, clean $300,000 basis. If she later sells at today's $400,000 value, she reports a $100,000 gain.
- Her holding period. Because the price equals the aunt's basis (a carryover basis), the niece inherits the aunt's holding period, so the property is long-term from day one.
The takeaway: a sale at cost can be entirely tax-free for the seller, but only when "cost" means adjusted basis and the property has not been depreciated. Depreciation is the single variable that breaks the clean result.
The Recipient's Basis: Where Families Get Tripped Up
To figure gain or loss on a future sale, the recipient needs a tax basis in the property. These rules differ from both an ordinary purchase and a pure gift, and they produce what we call a dual basis: one figure for measuring future gain and a different one for measuring future loss.
Basis for a Future Gain
For gain, the recipient's basis is the greater of what they paid or the transferor's adjusted basis at the time of transfer. This preserves the transferor's unrecovered investment. In Example 1, the child's gain basis is $250,000 (the price paid, which exceeds the parent's $150,000 basis). If the child later sells for $500,000, the reportable gain is $250,000.
Basis for a Future Loss
A separate ceiling applies when the recipient sells at a loss: the loss basis cannot exceed the property's fair market value at the time of the original transfer. This stops the recipient from claiming a loss on value that evaporated while the property was still in the transferor's hands.
This is where the dual basis creates a genuine quirk. If the gain basis is higher than the loss basis, a future sale price that lands between them produces neither gain nor loss. For instance, if a parent transfers property worth $60,000 (with a $90,000 basis) to a child for $30,000, the child's gain basis is $90,000 while the loss basis is capped at $60,000. Sell later for $75,000 and the result falls in the gap, so the child reports nothing at all.
Gift Tax Paid Can Lift the Basis
If the transferor actually pays gift tax on the transaction, a portion of that tax is added to the recipient's basis under Section 1015(d). Most family transfers never trigger an out-of-pocket gift tax thanks to the lifetime exemption, but where one does, this adjustment trims the recipient's future bill.
Gift Tax Consequences
The gift slice of the transfer is treated like any other gift. The first $19,000 to any single recipient in 2026 is fully excluded. Anything above that counts against your $15,000,000 lifetime exemption rather than producing an immediate check to the IRS. Taxable gifts simply chip away at what you can ultimately pass to heirs free of estate tax; only after the full exemption is exhausted does gift tax actually become payable.
Gift Splitting for Married Couples
Married clients can elect to treat a gift as though each spouse made half. That doubles the annual exclusion to $38,000 per recipient and lets both lifetime exemptions absorb the taxable portion. The trade-off: gift splitting requires both spouses to file a gift tax return for the year, even the spouse who gave nothing.
When the Buyer Is a Charity: Different Rules Apply
Bargain sales to a qualified charity follow a less generous income tax path. Instead of offsetting the sale price with your full basis, you allocate basis between the sale and gift portions in proportion to the sale price over fair market value.
Say you own property worth $200,000 with a $100,000 basis and sell it to a charity for $120,000. The allocated basis is $100,000 × ($120,000 / $200,000) = $60,000, so your taxable gain is $60,000. The same numbers in a family transfer would let your full $100,000 basis offset the $120,000 price, leaving only $20,000 of gain. The consolation is that the gift portion may generate a charitable income tax deduction; for donated property over $5,000, you must complete Section B of Form 8283 and attach a qualified appraisal.
Filing and Recordkeeping
What the Transferor Files
File Form 709, the federal gift tax return, if the gift portion to any single recipient tops $19,000, or if you elect gift splitting (regardless of amount). Filing is required even when no tax is due because the lifetime exemption covers it. Form 709 is due April 15 of the following year; extending your income tax return extends it too, and Form 8892 buys a separate six-month extension if needed. Any capital gain on the sale portion goes on Schedule D. Income tax and gift tax travel on separate returns.
What the Recipient Keeps
The recipient has nothing to file right away, but the recordkeeping matters enormously. Hold onto documentation of the transferor's adjusted basis, the price paid, the fair market value at transfer, and any gift tax the transferor paid. Without these, calculating gain or loss on a future sale becomes guesswork, and the IRS can ask for the records years down the road. Keep them at least until the property is sold and the statute of limitations on that return has closed.
Holding Period
When the recipient's basis carries over from the transferor (because the transferor's basis was higher than the price paid), the recipient also inherits the transferor's holding period, so the property may already qualify for long-term rates on day one. When the basis instead equals the price paid, the holding period restarts on the transfer date. For anyone planning to resell within a year or two, that distinction can meaningfully change the rate that applies.
Frequently Asked Questions
Do I have to pay tax if I sell my house to a family member at cost?
Not necessarily. If "cost" means your adjusted basis and you have not depreciated the property, your gain is zero. But if you sell a depreciated rental at your original cost, the depreciation you claimed comes back as gain, taxed up to 25% as unrecaptured Section 1250 gain.
Is selling property below market value to family considered a gift?
Yes, in part. The difference between the property's fair market value and the price paid is treated as a gift, while the amount paid is treated as a sale. The two halves are taxed under different systems.
What is the gift tax exclusion for 2026?
The annual exclusion is $19,000 per recipient for 2026, and the lifetime exemption is $15,000,000 per person. Gifts above the annual exclusion reduce your lifetime exemption but rarely trigger an immediate tax.
Do I have to file a gift tax return if no tax is owed?
Yes. If the gift portion to any one recipient exceeds the $19,000 annual exclusion, or if you elect gift splitting with your spouse, you must file Form 709, even when the lifetime exemption covers the amount and nothing is actually owed.
What basis does the family member receive?
A dual basis: for measuring a future gain, the greater of the price paid or your adjusted basis; for measuring a future loss, no more than the fair market value at the time of transfer.
The Bottom Line
Part-sale, part-gift transfers sit right at the intersection of income tax, gift tax, and estate planning, where a small misstep on valuation or basis can echo for years. The good news is that almost every pitfall in this guide is avoidable with planning done before the transfer closes. Once the deal is signed, your options narrow fast.
At Shahbaz & Associates, we help families model sale-price scenarios, coordinate the appraisal, prepare Forms 709 and Schedule D, and document the basis the recipient will rely on for years to come. If you are thinking about selling property to a loved one below market value, let's talk while there is still room to plan.