Loss Deduction Rules for Property Sales Between Related Parties

When dealing with the disposition or sale of property between related parties, taxpayers must follow strict rules set by the Internal Revenue Code (IRC), especially Section 267. These rules are designed to stop people from creating tax losses that do not reflect real economic losses. Understanding who qualifies as a related party, what transactions are covered, and how to handle documentation is essential for anyone involved in these types of property sales. This guide explains the requirements, eligibility, documentation, and practical steps for taxpayers, using simple language and real-life examples.

Who Qualifies as a Related Party?

The first step is to determine if the transaction involves a related party. The IRS has a clear definition under IRC §267(b):

• Family members: This includes brothers, sisters, half-brothers, half-sisters, spouse, parents, grandparents, children, and grandchildren. Only these direct relationships count. In-laws and step-relatives are not included.
• Entities controlled by the taxpayer: If you own more than 50% of a partnership or corporation, either directly or through family members, that entity is considered related to you.
• Tax-exempt organizations: If you or your family control a charitable or educational organization, it is a related party.
• Certain corporations and trusts: If there is overlapping ownership of more than 50% between you and another corporation, partnership, or trust, these are also related parties.

Example:
If you sell property to your brother, this is a related-party transaction. If you sell property to your cousin or your brother-in-law, it is not considered related under these rules.

Detailed Eligibility Criteria with Examples

To see if the loss disallowance rules apply, ask these questions:

1. Is the transaction a sale or exchange of property?
   The rules apply to both sales and exchanges, not just cash sales.

2. Is the transaction between you and a related party?
   Use the definitions above to check.

3. Is the transaction a complete liquidation of a corporation?
   If yes, the loss disallowance rule does not apply.

Example 1:
You sell your car to your daughter for less than you paid for it. You cannot deduct the loss on your tax return.

Example 2:
You sell stock to a corporation where you own 60%. This is a related-party transaction, and the loss is not deductible.

Example 3:
You sell property to a charity that you and your spouse control. This is also a related-party transaction.

Special Note:
If you sell property to a related party and later buy it back, or if the property changes hands through a series of related parties, the rules still apply. The IRS looks at both direct and indirect transactions.

Required Documentation

Proper documentation is key for any taxpayer involved in the disposition or sale of property with a related party. Here’s what you need to keep:

• Proof of relationship: Documents showing family ties or ownership percentages in entities.
• Purchase and sale agreements: Contracts that show the terms of the sale or exchange.
• Proof of payment: Bank statements, checks, or other evidence of payment.
• Original basis documents: Receipts or records showing how much you paid for the property originally.
• Depreciation records: If the property is depreciable, keep all records of depreciation claimed.
• Correspondence: Any emails or letters about the transaction.

Official IRS Forms and Resources:

• Form 8949, Sales and Other Dispositions of Capital Assets: Used to report sales and exchanges of capital assets. Form 8949 official link
• Schedule D (Form 1040), Capital Gains and Losses: Summarizes capital gains and losses from all sales. Schedule D official link
• IRS Publication 544, Sales and Other Dispositions of Assets: Offers detailed guidance on reporting property sales. Publication 544 official link

Application Process Overview

If you are a taxpayer involved in a related-party property sale, follow these steps:

1. Identify the relationship: Confirm if the buyer or seller is a related party as defined by the IRS.
2. Calculate your basis: Determine your original cost in the property, including improvements and depreciation.
3. Determine the sale price: Use the actual price agreed upon in the transaction.
4. Apply the loss disallowance rule: If you sold at a loss, you cannot deduct the loss on your tax return.
5. Report the transaction: Use Form 8949 and Schedule D to report the sale. If you later sell the property to an unrelated party, adjust your gain or loss as required.
6. Keep records: Maintain all documentation for at least three years after filing your tax return.

Practical Tips for Meeting Requirements

• Double-check relationships: Make sure you understand who counts as a related party. Mistakes here can lead to IRS penalties.
• Track basis carefully: If you buy property from a related party, your basis is usually the same as theirs. This affects your gain or loss when you sell.
• Understand the exceptions: The only major exception is for complete liquidation of a corporation. In this case, losses may be allowed.
• Watch out for indirect sales: Even if you sell to a third party who is then involved with a related party, the rules may still apply.
• Consult a tax professional: Related-party transactions can be complex. A CPA or tax attorney can help you avoid costly mistakes.

Key Provisions and How They Affect Taxpayers

1. Loss Disallowance on Sales to Related Parties
   If you sell property at a loss to a related party, you cannot deduct the loss. This rule applies even if you sell at fair market value and the transaction is real.

   Example:
   Your brother sells you stock for $7,600. His cost was $10,000. He cannot deduct the $2,400 loss. If you later sell the stock to an unrelated party for $10,500, your reportable gain is only $500 (the $2,900 gain minus the $2,400 loss not allowed to your brother).

2. Basis Adjustment and Gain Recognition
   When you buy property from a related party at a loss, your basis is the same as the seller’s. If you sell at a gain, you subtract the disallowed loss from your gain. If you sell at a loss, you can only deduct the loss based on what you paid, not the seller’s original basis.

   Example:
   Using the same stock example, if you sell the stock for $6,900 instead of $10,500, your recognized loss is only $700 (your $7,600 basis minus $6,900). You cannot deduct the loss that was not allowed to your brother.

3. Special Rules for Exchanges
   If you exchange property with a related party, special rules apply. You must hold the property for at least two years after the exchange. If you sell it sooner, you may have to recognize gain unless an exception applies (such as death or involuntary conversion).

4. Bonus Depreciation Limitations
   If you buy depreciable property from a related party, you cannot claim full bonus depreciation. This prevents you from taking large deductions based on an inflated basis.

5. Complete Liquidation Exception
   If the transaction is a complete liquidation of a corporation, the loss disallowance rule does not apply. Losses may be deducted in this case.

Recent Developments and 2024-2025 Updates

As of July 27, 2025, there have been no major changes to these rules. The IRS continues to enforce them strictly to prevent tax avoidance. According to analysis by VisaVerge.com, tax experts stress the importance of understanding these rules, especially for family businesses and closely held corporations. The IRS has also clarified that these rules apply to both direct and indirect transactions, making it even more important to review all parties involved in a sale.

Practical Effects on Taxpayers

• No immediate tax benefit: If you sell property at a loss to a related party, you cannot use that loss to reduce your taxes.
• Careful planning needed: If you plan to sell property that was bought from a related party, you must track the basis and any disallowed losses.
• Depreciation complications: Buying depreciable property from a related party can limit your deductions.
• Documentation is critical: The IRS may ask for proof of relationships, basis, and sale details.

Step-by-Step Considerations for Related-Party Property Sales

1. Identify Related Parties: Use the IRS definitions to confirm if the transaction is between related parties.
2. Determine Basis and Sale Price: Know the original cost and the sale price to figure out gain or loss.
3. Apply Loss Disallowance Rules: If there is a loss, remember it cannot be deducted.
4. Track Basis for Future Sales: If you later sell the property, adjust your gain or loss as required.
5. Check for Exceptions: See if the transaction qualifies for the complete liquidation exception.
6. Review Depreciation Rules: If the property is depreciable, check for bonus depreciation limits.
7. Maintain Documentation: Keep all records to prove your case if the IRS asks.
8. Consult Tax Advisors: For complex cases, get professional help.

Background and Historical Context

The rules on the disposition or sale of property between related parties have been in place for decades. They were created to stop people from creating fake losses to lower their taxes. In 1989, Congress added more restrictions for exchanges between related parties to stop people from shifting the basis of property to avoid taxes. These rules have not changed much in recent years and are enforced by both the IRS and the courts.

Expert Perspectives

Tax professionals warn that related-party sales often do not provide any immediate tax benefit because of the loss disallowance rule. However, with careful planning, related-party transactions can sometimes help use up capital loss carryforwards. The IRS sees these rules as essential for keeping the tax system fair and stopping abuse.

Future Outlook

There are no expected changes to these rules in the near future. Taxpayers should keep an eye on IRS guidance, but the basic rules are likely to stay the same.

Official Resources and Contacts

For more information, visit the IRS official page on Related-Party Transactions. You can also find detailed instructions in IRS Publication 544 and the Internal Revenue Code Section 267. For personal advice, consult a CPA or tax attorney.

Actionable Takeaways

• Always check if your transaction involves a related party before claiming a loss.
• Keep detailed records of all related-party sales, including proof of relationship and basis.
• Use the correct IRS forms and follow reporting instructions carefully.
• If you are unsure, seek help from a tax professional to avoid costly mistakes.
• Remember that the rules are strict and enforced, so careful planning is essential.

By following these steps and understanding the rules, taxpayers can avoid common pitfalls and make sure they comply with IRS requirements for the disposition or sale of property involving related parties.

Learn Today

Disposition → The act of selling, exchanging, or transferring property ownership.
Related Party → Individuals or entities connected by family or control under IRC §267 rules.
Loss Disallowance → Tax rule preventing deduction of losses on sales between related parties.
Basis → Original cost or investment in property used to calculate gain or loss.
Depreciation → Deducting the cost of property over time for tax purposes.

This Article in a Nutshell

The IRC §267 governs property sales between related parties to stop fake loss claims. Taxpayers must identify relationships, document basis, and handle loss disallowance carefully to comply with IRS rules and avoid penalties in related-party transactions.
— By VisaVerge.com