Selling a rental to a relative on seller financing looks simple until the gift tax rules and the AFR floor hit the same conversation

The assumption doing the most work in most of these deals is that the buyer's ability to service the note today reflects their ability to service it in year three or year five. A relative who is stretched at closing has no buffer when something else goes wrong, and your remedies at that point are foreclose on family or absorb the loss. Neither is clean.

The gap you named between serviceable payment and clean market proceeds is the right place to look, but there is a second gap worth quantifying: the difference between your note balance and the property's future market value at various default scenarios. If the property is worth 300k at origination and you carry 270k, a default in year two after values drop 10 to 15 percent leaves you recovering less than you are owed even before you account for carrying costs, legal fees, and whatever deferred maintenance accumulated. The deed of trust protects your legal position, but it does not protect you from the math of a declining market with a high loan-to-value note.

On the balloon question, the structure matters more than people admit. A long amortization with no balloon feels generous, but it also means you carry the credit exposure for decades. A shorter balloon forces the relative to refinance or sell, which is a hard conversation to have at origination but a harder situation to manage if you discover in year eight that they cannot qualify for conventional financing and you have no exit.

The installment sale tax treatment is worth running carefully with a CPA. Spreading the gain is the appeal, but the basis allocation, depreciation recapture timing, and the interaction with AFR imputation on a related-party note all compound. Get that modeled before you set terms, and confirm the current AFR in writing at the time you draft the note, because locking a rate against a month-old figure you read somewhere is a documentation problem.

What is the relative's current debt-to-income picture, and have you stress-tested the payment against a scenario where their income drops 20 percent?

The AFR point in this thread is exactly right, and the mechanism is worth spelling out for anyone new to it.

The Applicable Federal Rate, or AFR, is a minimum interest rate the IRS sets each month for loans between related parties. If you charge less than that rate, the IRS treats the deal as though you charged the AFR anyway. The difference between what you actually charged and what the AFR says you should have charged becomes "imputed interest," meaning income you owe tax on even though you never received it. If that imputed amount also clears the annual gift tax exclusion (currently $18,000 per person in 2024), you may owe gift tax on top of that. So a below-market rate to be generous can create a tax bill in two places at once. A CPA can pull the current AFR and confirm where your rate needs to land before you write the note.

The deed of trust point matters just as much. A deed of trust is a recorded legal document that gives the lender a secured claim against the property. Without it, if the buyer stops paying, your only option is a personal lawsuit. With it, you can foreclose, meaning you can move to take the property back through a legal process. That changes your position entirely.

The question the thread ends on is the one that actually determines whether this deal makes sense. The gap between what your relative can service and what a market sale would net you is a real number, and you should calculate it before you sign anything. If you are comfortable making that gap a deliberate gift, that is a valid choice. If you are hoping the number works out, that is where deals between family members go wrong.

A real estate attorney should draft or review the note and deed of trust. This is not a place to use a template and hope.

What does the property currently appraise for, and do you know yet what rate your relative would need to make the payments workable?

The part I have never seen work is the handshake deed-of-trust situation where the seller says "we'll record it later when things settle down." Later doesn't come, the relative refinances or sells, and the original seller is an unsecured creditor arguing with an escrow officer.

What's the actual purchase price relative to appraised value here, because that gap matters more than the rate question once you run the numbers on imputed interest plus gift exposure stacking in the same year?

The line between a below-market price and a gift is what the IRS calls foregone interest, but there is a parallel issue nobody in this thread has touched: if you sell below fair market value and the difference exceeds the annual exclusion, that spread itself is a taxable gift independent of the interest rate problem. So you can charge the correct AFR on a 270k note and still trigger gift tax if the property was worth 320k when you sold it.

What decides how serious that is? The down payment percentage, because it signals whether your collateral covers a realistic default scenario, but more immediately it tells me how far below FMV you went and whether the discount needs to be documented as intentional gift or justified by a legitimate appraisal.

What was the agreed sale price relative to a current appraised value?

The deed of trust point is the one people skip because it feels aggressive to record a lien against your cousin's house. Do it anyway. I watched a friend lose $40k because the note was real and the collateral was a handshake.

What is the balloon situation you are thinking, are you planning one at all, or is this a straight 30-year ride?

The 7-year balloon on a 30-year am is the part I'd want to model before anything else, because that's where the relative actually has to refinance at whatever rate exists in 2031 or 2032, and if they can't qualify then, your "clean family deal" becomes a foreclosure or a modification negotiation that poisons everything downstream. I staged a flip in Chandler last year where the original seller-financed deal between cousins had exactly this structure, and the balloon came due when rates were ugly and the buyer's DTI had gotten worse. The seller didn't want to foreclose on family, so they extended twice, and now the note is barely earning AFR on a property that's appreciated 40 percent and the seller can't pull any of it out. What's the relative's realistic refi timeline, meaning do they have a path to conventional financing in the next five to seven years or are you essentially writing a permanent note?