My in-laws want to sell us their home for $100,000, so that we can fix and flip it. Should we refinance our mortgage to pay for this?

With that said, my husband and I are trying to see what the best option is for all of us. My in-laws want to sell us their home for about $100,000, which is very likely below market value. But it needs a lot of work, like water in the basement due to a foundation matter ($7,000 – $8,000); a new roof ($12,500); and a new air conditioning/heating unit ($10,000). The rest of the issues are cosmetic — bathroom remodels, new flooring and paint throughout the house and landscaping (front and back).

We can refinance our home for 15 years — we currently have eight years left on our mortgage — to purchase and fix up their home. But what do you believe is the best way to go about this, as we don’t want to be caught up in taxes? What happens if they sell us their house at a price below market value? What if they give the house to us? We plan to sell the house once it is renovated.

Thank you for your time.

Sincerely,

In-laws Want Out

‘The Big Move’ is a MarketWatch column looking at the ins and outs of real estate, from navigating the search for a new home to applying for a mortgage.

Do you have a question about buying or selling a home? Do you want to know where your next move should be? Email Jacob Passy at [email protected].

Dear In-laws,

It’s good that your in-laws are able to recognize that they need to downsize and relocate. Too often we see older individuals hold onto the family home well beyond the time when they can manage such a property, in the hopes of passing the property onto their kids. The trouble is in many cases, the younger generation doesn’t want to move into the home — and by that point, all the accumulated neglect from the parents not being able to manage the maintenance leaves the house in such disrepair that whatever inheritance was meant to be passed onto the next generation is whittled away by the costs to get the home into a sellable state.

Your in-laws are doing the right thing by being proactive and moving to a home that’s more manageable for them now, rather than making this your problem further down the road. Besides, who wouldn’t prefer sitting back, relaxing and finally letting someone else mow the lawn once they are retired and living out their golden years?

There are two major tax considerations your family needs to think about before moving forward with the plan your in-laws seem most interested in. Whether they gift you the home outright or have you pay a pittance compared to the home’s actual appraised value, either way it would be considered a gift in the eyes of the Internal Revenue Service. But that doesn’t mean they’d actually be paying taxes on that gift.

So let’s say the home is really worth $200,000, and they only have you pay them $100,000 for it. That would be the equivalent of them giving you a $100,000 gift. As of 2021, the annual exclusion, per person, for gifts to each recipient is $15,000. If your parents jointly own the home, and they sell it to your husband, then up to $30,000 could be excluded, meaning the total taxable amount would be $70,000.

Even then, they wouldn’t need to pay taxes on that gift. Instead, they could count it toward their lifetime gift and estate tax exemption of $11.7 million, which is the amount that any individual person can pass along to others before gifts are taxed. Assuming your in-laws aren’t millionaires, you should be in the clear.

That said, you should make sure to do the transaction by the book to avoid triggering any unnecessary red flags with the IRS. At the very least, hire a real-estate attorney to guide you through the necessary paperwork involved in a for-sale-by-owner situation. You should also consider hiring a real-estate agent to perform a so-called comparative market analysis, which would give you a sense of the home’s valuation.

Separately, you and your husband will need to consider your own potential financial liability if you buy the house, renovate it and then sell it. Even though you’re purchasing a home from family, this is essentially no different from what home flippers do throughout the country.

While shows on HGTV may make it look foolproof, it is very much a gamble. From the time you purchase the home to the time you are ready to sell it, the housing market could go through major upheaval. And suddenly you could find yourself struggling to offload the property and get a return.

Interest rates are low now, so seeking out a cash-out refinance in order to free up money to purchase the home isn’t a bad idea in and of itself. Keep in mind that refinances don’t come for free — you’ll need to pay closing costs on the new loans, which can add up to thousands of dollars.

My bigger worry is whether you and your husband have enough cash on hand to cover the cost of all the extensive repairs the home will need to get it to a sellable state. The last thing you’d want to do is borrow even more money to finish the renovations and sell the home, since that would eat away at any possible return on your investment. Not to mention that you’d be putting your own home at risk if you fall into dire straits and find yourselves unable to afford your monthly mortgage payments.

And let’s say you do manage to turn a profit at the end of all that, then you’ll be facing a potentially huge tax bill. “Taxpayers who decide to try their luck at house flipping and flip a single home for resale would likely be considered a dealer instead of an investor,” Albert Allen, a tax research analyst at The Tax Institute at H&R Block HRB, -0.76%, wrote in a blog post.

For starters, since you won’t be holding onto the home for long-term, you’d owe taxes on short-term capital gains (i.e. the profit from the sale). Those are taxed at your normal income tax rate. Plus, since you’re a “dealer” for tax purposes, you would have to pay double Federal Insurance Contributions Act, or FICA, taxes. All told, your taxation rate could range between 25.3% and 52.3%, according to We Lend LLC.

If you were to turn flipping homes into a side hustle, you could side-step the capital gains tax by investing the money earned into another investment property through what’s known as a 1031 exchange. And you could take deductions for real-estate taxes, labor cost, materials cost, etc.

Still, flipping homes is not for the faint of heart. Before you and your in-laws make any concrete decisions, I would hire a home appraiser or another real-estate professional to evaluate the property and give you a fuller sense of the costs involved with selling the home. You might find that you all are better off selling the home as is to a professional home-flipper, and having your in-laws gift you the proceeds if they still want to make a kind gesture.