12.6 Related Party Transactions
Key Takeaways
Section 267: losses on related party sales = DISALLOWED.
Section 1239: gains on depreciable property to related party = ordinary income.
Family: siblings, spouse, ancestors, lineal descendants.
NOT family: in-laws, aunts/uncles, cousins.
50% ownership = related party (entities).
Matching rule: deduction when income reported.
Why This Matters for the Exam
Related party rules prevent tax abuse. Know who is "related" and the consequences.
Section 267: Loss Disallowance
| Rule | Effect |
|---|---|
| Loss | DISALLOWED on sale to related party |
| Buyer offset | Can reduce future gain (not create loss) |
Section 267 Example
| Transaction | Amount |
|---|---|
| Father's basis | $50,000 |
| Sale to Son | $30,000 |
| Father's loss | $20,000 (DISALLOWED) |
| Son's basis | $30,000 |
| Son sells to stranger | $60,000 |
| Son's gain | $60,000 - $30,000 = $30,000 |
| Offset | $20,000 (father's disallowed loss) |
| Taxable | $10,000 |
Section 1239: Gain Recharacterization
| Rule | Effect |
|---|---|
| Depreciable property | Sold to >50% controlled entity |
| Gain character | Ordinary income (not capital/1231) |
Section 267 Matching Rule
| Scenario | Effect |
|---|---|
| Accrual entity owes cash-basis owner | |
| Deduction | When owner reports income |
| Purpose | Prevent timing abuse |
Who Are Related Parties?
| Related | Not Related |
|---|---|
| Siblings (whole/half) | In-laws |
| Spouse | Aunts/Uncles |
| Ancestors (parents, grandparents) | Cousins |
| Lineal descendants (children, grandchildren) | Step-parents |
Entity Relationships
| Test | Related |
|---|---|
| Individual and >50% owned entity | Yes |
| Two entities with >50% common ownership | Yes |
Constructive Ownership (Attribution)
| Type | Rule |
|---|---|
| Family | Own what spouse, siblings, descendants own |
| Entity | Own proportional share of entity holdings |
Real-World Scenario
Scenario: Corporation (accrual) owes $10,000 interest to 75% shareholder (cash). Accrued Dec 31, paid Jan 15.
- Matching rule: Corporation cannot deduct until shareholder reports income.
- Shareholder reports: January (cash basis).
- Corporation deducts: January (not December).
On the Exam
Question types to practice on related parties:
- Loss Questions: "Can father deduct loss on sale to daughter?"
- Matching Questions: "When can corporation deduct?"
- Family Questions: "Is son-in-law a related party?"
The key is to remember: §267 = losses disallowed (buyer gets offset). §1239 = ordinary gain on depreciable. Family = siblings, spouse, ancestors, descendants. In-laws = NOT related.
Sell truck to daughter: $8,000 basis, $5,000 sale price. How reported?
$3,000 §1231 loss
$3,000 ordinary loss
$0 loss (§267 disallowed)
$3,000 LTCL
Corporation (accrual) owes 75% shareholder (cash) interest. Accrued Dec 31, paid Jan 15. Deduction year?
2025
2026
Half each year
Disallowed
Which is NOT a related party under §267?
Half-brother
Grandmother
Son-in-law
Spouse
Sections you finish are checked off in the contents.