26.4 Related-Party, Wash-Sale, and Imputed-Interest Traps
Key Takeaways
- Anti-abuse rules override the result a plain sale formula would give; identify relationships, repurchases, and unstated interest before accepting a loss or deferral.
- IRC Section 267 disallows losses on sales between related parties; the related buyer may use the disallowed loss only to reduce a later GAIN on a sale to an unrelated party.
- The wash-sale rule disallows a securities loss when substantially identical securities are bought within the 61-day window (30 days before through 30 days after the sale).
- IRC Section 1239 turns gain on depreciable property sold to a more-than-50%-controlled related party into ordinary income for the seller.
- Below-market and seller-financed transactions create imputed interest under the applicable federal rate, splitting payments into interest plus a deemed dividend, compensation, gift, or contribution.
Why Anti-Abuse Rules Are Tested
Related-party sales, wash sales, and imputed-interest rules exist because a taxpayer can otherwise keep the same economic position while claiming a tax benefit. The 2026 TCP Blueprint explicitly lists related-party transactions, direct and indirect (constructive) ownership, subsequent dispositions of property bought from a related party, and imputed interest. REG also tests wash-sale basis within the property-transactions area.
In a simulation these issues hide in ordinary-looking documents: a bill of sale, a stock trade confirmation, a promissory note, or a shareholder-loan ledger. The relationship or the repurchase date — not the price — is what changes the tax answer.
Related-Party Loss Disallowance (Section 267)
Under IRC Section 267, losses on sales or exchanges between related parties are disallowed. Related parties include lineal family (spouse, ancestors, descendants) and siblings, plus an individual and a more-than-50%-owned corporation, and various entity combinations. The exam supplies ownership percentages; apply constructive ownership (you are deemed to own stock owned by family and related entities) before deciding the parties are related.
The disallowed loss does not vanish for all purposes. If the related buyer later sells to an UNRELATED party at a gain, the buyer may use the previously disallowed loss to reduce that gain — but only enough to reach zero; it can never create or increase a loss. Worked example: Parent sells property with basis $100,000 to Child for $70,000; Parent's $30,000 loss is disallowed. Child later sells to an unrelated buyer for $95,000. Child's realized gain is $25,000, fully offset by $25,000 of the prior disallowed loss to a recognized gain of $0. The unused $5,000 simply disappears.
Section 1239 — Related-Party Depreciable Property
IRC Section 1239 is a separate trap: GAIN on a sale of depreciable property to a more-than-50%-controlled related party (such as an individual and a controlled corporation or partnership) is ordinary income to the seller. The policy is to stop a taxpayer from selling depreciable property to a related entity that gets a stepped-up depreciable basis while the seller pays only capital-gain rates.
Wash Sales
A wash sale occurs when stock or securities are sold at a LOSS and substantially identical stock or securities are acquired within 30 days before OR after the sale — a 61-day window (verified 2026): 30 days before, the sale date, and 30 days after.
When the rule applies, the loss is disallowed currently. The disallowed loss is added to the basis of the replacement shares, and the old shares' holding period tacks onto the replacement shares, preserving the loss for a later sale. Two traps: (1) the rule applies only to LOSSES — gains are always recognized; (2) replacement shares bought inside a traditional or Roth IRA cause the loss to be permanently disallowed rather than rolled into outside basis.
Imputed Interest
A note with no interest or below-market interest is not respected as written. The imputed-interest rules recharacterize part of the transaction as interest using the applicable federal rate (AFR) (or another rate supplied in the facts). The result creates interest income to one party and interest expense to the other, subject to normal deduction limits.
The "other side" of the deemed transfer depends on the relationship: a corporation-to-shareholder below-market loan produces a deemed dividend; employer-to-employee produces deemed compensation; one individual to another produces a deemed gift; a shareholder-to-corporation loan produces a capital contribution. Do not memorize indexed dollar de-minimis exceptions for this chapter; use the rate, principal, payment schedule, and relationship the question supplies.
Trap Checklist
| Question to ask | Why it matters |
|---|---|
| Are the parties family, controlled entities, or common owners (constructive ownership)? | Section 267 disallows the loss; Section 1239 may make the gain ordinary |
| Was a loss security replaced inside the 61-day wash-sale window? | The current loss is disallowed and added to replacement-share basis |
| Does the note state adequate (AFR) interest? | Part of the payment stream may be imputed interest |
| Is the later buyer unrelated? | A previously disallowed related-party loss may reduce a later GAIN only |
The exam pattern is consistent: compute the normal result first, then ask whether an anti-abuse rule changes the timing, basis, or character of that result.
Constructive Ownership Mechanics
Section 267 relatedness often turns on constructive ownership rather than direct shares. An individual is treated as owning the stock owned by his or her spouse, children, grandchildren, parents, and grandparents (siblings count as related for the family-loss rule but a sibling's stock is NOT attributed under the entity ownership tests). Stock owned by a corporation, partnership, estate, or trust is attributed proportionately to its owners or beneficiaries. Worked example: an individual directly owns 30% of a corporation, and her father owns another 25%.
Through family attribution she is treated as owning 55%, which exceeds the more-than-50% threshold, so a loss on a sale between her and that corporation is disallowed and a gain on depreciable property could be ordinary under Section 1239. Always run the attribution before concluding the parties are unrelated.
Wash-Sale Edge Cases You Must Know
The wash-sale rule reaches more than a literal repurchase of the same stock. "Substantially identical" includes options and contracts to acquire the same stock, and a purchase by the taxpayer's spouse or controlled corporation can trigger it. Selling at a loss in a taxable account and rebuying the identical fund in an IRA within the window permanently disallows the loss — there is no basis to step up in the IRA. By contrast, switching to a genuinely different security (a different issuer's bond, or an S&P 500 fund versus a total-market fund) generally avoids the rule.
Tax-loss harvesting strategies live or die on this 61-day boundary, and the exam frequently gives a calendar so you can count whether the repurchase fell inside it.
Imputed Interest and Original Issue Discount
When a seller finances a sale with a note bearing inadequate stated interest, the tax law imputes interest at the applicable federal rate and treats the deal as if the principal were smaller and the interest larger. This both reduces the seller's reported sale price (and thus gain) and reshapes the buyer's basis. The same machinery underlies original issue discount (OID), where a debt instrument issued below its redemption price forces the holder to accrue interest income over the term rather than waiting for maturity.
On the exam, when a note's stated rate is below the AFR or a bond is issued at a discount, separate the economic interest from the principal before computing either party's gain, basis, or income.
A taxpayer sells property with a basis of $100,000 to her brother for $70,000. The brother later sells the property to an unrelated buyer for $95,000. Ignoring depreciation and other adjustments, what is the brother's recognized gain on the later sale?
A corporation makes a below-market loan to a shareholder. In a CPA exam simulation, what should the candidate do first when analyzing the tax treatment?