Selling a Rental to a Family Member Below Market: Gift of Equity and Tax

A below-market sale splits into a sale at the price paid and a gift of the discount

Reg. section 1.1001-1(e) covers a transfer that is in part a sale and in part a gift. The transferor has a gain to the extent the amount realized exceeds adjusted basis, and no loss is sustained if the amount realized is less than adjusted basis. Its first example is the standard family case: property with a $30,000 basis and a $90,000 value sold to a son for $60,000 produces a $30,000 gain and a $30,000 gift.

Publication 544 restates the rule under Bargain Sale. Note what it does not do: outside the charitable rules, basis is not split between the sale part and the gift part, so the full adjusted basis offsets the price. A discount deep enough to bring the price at or below your basis means no income tax on your side at all.

The gain you do recognize keeps its usual character. On a rental, the depreciation you took is taxed first as unrecaptured section 1250 gain at up to 25 percent, and only the excess is long-term capital gain, the ordering set out in capital gains tax on a rental. The sale is reported on Form 4797 with the actual price as the amount realized, not the appraised value.

The discount is a gift: Form 709 is due if it passes the annual exclusion, but tax is rare

Rev. Proc. 2025-32 sets the 2026 annual exclusion at $19,000 per recipient and the basic exclusion amount at $15,000,000, the figure set by Public Law 119-21. The Form 709 instructions require a return when gifts to one person other than your spouse exceed the annual exclusion, and when spouses elect to split gifts, whatever the amount.

The return is due April 15 of the year after the gift. Adequate disclosure requires either a qualified appraisal or a detailed description of how value was set, and the instructions ask you to attach any appraisal used for real estate. Because the gift equals value minus price, the appraisal is the number the whole transaction rests on.

Gift tax is owed only after the lifetime exclusion is used up, so most family sales file Form 709 and pay nothing. The cost is that the exclusion used now is not available to the estate; portability of the estate exemption explains how a couple's exclusions combine.

Worked example: a $500,000 rental sold to a daughter for $300,000

Hypothetical, round figures. A parent bought a rental for $300,000, has taken $100,000 of depreciation, and sells it in 2026 to a daughter for $300,000 when an appraisal puts it at $500,000. Adjusted basis is $200,000, so the parent's gain is $100,000. All of it is depreciation-related unrecaptured section 1250 gain, taxed at ordinary rates capped at 25 percent.

The gift is $200,000. After the $19,000 annual exclusion the taxable gift is $181,000, or $162,000 if the parent's spouse consents to split the gift, and it reduces the lifetime exclusion rather than producing tax. The daughter's basis under Reg. section 1.1015-4 is the greater of the $300,000 she paid or the parent's $200,000 basis, so $300,000.

Sold at full value, the parent would have a $300,000 gain. The discount moved $200,000 of built-in gain to the daughter, who will pay it when she sells unless she holds until death or exchanges. Run your own numbers with your CPA.

Losses between family members are disallowed, and an installment note adds a two-year trap

If the property is worth less than your basis, the part-gift rule already denies a loss, and section 267 disallows any loss on a sale between family members even at full price. Family here means brothers and sisters, spouse, ancestors and lineal descendants. Section 267(d) lets the buyer reduce a later gain on resale by the loss you could not take.

Many family sales are seller-financed. Under section 453(e), if the related buyer resells within two years and before you collect the note, the buyer's sale price is treated as received by you at that time. Carrying a note for a buyer covers how a note interacts with an exchange.

An exchange can defer the sale part, but only the cash portion is exchange proceeds

The gift portion produces no proceeds, so only the price the family member pays can be routed through a qualified intermediary and reinvested. With a basis at or above the discounted price there is little gain to defer, and an exchange adds cost without benefit. With a low basis, the sale portion can go into replacement property under section 1031 like any other sale.

The related-party rule in section 1031(f) is written for exchanges with a related person and carries a two-year holding requirement. Before you route a family sale through an exchange, read selling to a family member in a 1031, who counts as a related party and the two-year rule. Replacement property can be a building you manage or a fractional interest in a traditional DST.