701 / How is a loss realized on a sale between related persons treated for income tax purposes?

A loss realized on the exchange of properties between related persons will also be disallowed under these rules.⁶ Whether loss is realized in transfers between spouses during marriage or incident to divorce is explained in Q 789.

For this purpose, persons are related if they are: (1) members of the same family (i.e., brothers, sisters, spouses, ancestors, and lineal descendants; but not if they are in-laws);⁷ (2) an individual and a corporation of which the individual actually or constructively owns more than 50 percent of the stock; (3) a grantor and a fiduciary of a trust; (4) fiduciaries of two trusts if the same person is the grantor of both; (5) a fiduciary and a beneficiary of the same trust; (6) a fiduciary of a trust and a beneficiary of another trust set up by the same grantor; (7) a fiduciary of a trust and a corporation of which the trust or the grantor of the trust actually or constructively owns more than 50 percent of the stock; (8) a person and an IRC Section 501 tax-exempt organization controlled by the person or members of his family (as described in (1) above); (9) a corporation and a partnership if the same person actually or constructively owns more than 50 percent of the stock of the corporation, and has more than a 50 percent interest in the partnership; (10) two S corporations if the same persons actually or constructively own more than 50 percent of the stock of each; (11) an S corporation and a C corporation, if the same persons actually or constructively own more than 50 percent of the stock of each; (12) generally, an executor and a beneficiary of an estate; or (13) possibly an individual and his or her individual retirement account (IRA).⁸ Special rules apply for purposes of determining constructive ownership of stock.⁹ The relationship between a grantor and fiduciary did not prevent recognition of loss on a sale of stock between them where the fiduciary purchased the stock in his individual capacity and where the sale was unrelated to the grantor-fiduciary relationship.¹⁰

Generally, loss will be disallowed on a sale between a partnership and a partner who owns more than a 50 percent interest, or between two partnerships if the same persons own more than a 50 percent interest in each.¹¹ Furthermore, with respect to transactions between two partnerships having one or more common partners or in which one or more of the partners in each partnership are related (as defined above), a portion of the loss will be disallowed according to the relative interests of the partners.¹² If the transaction is between a partnership and an individual who is related to one of the partners (as defined above), any deductions for losses will be denied with respect to the related partner’s distributive share, but not with respect to the relative shares of each unrelated partner.¹³ Loss on a sale or exchange (other than of inventory) between two corporations that are members of the same controlled group (using a 50 percent test instead of 80 percent) is generally not denied but is deferred until the property is transferred outside the controlled group.¹⁴

If the related person to whom property was originally sold (or exchanged), sells or exchanges the same property (or property whose tax basis is determined by reference to such property) at a gain, the gain will be recognized only to the extent it exceeds the loss originally denied by reason of the related parties rules.¹⁵

Special rules apply to installment sales between related parties (see Q 667) and to the deduction of losses (see Q 8002 to Q 8022).

In a case of first impression, the Tax Court held that IRC Section 382(l)(3)(A)(i)—which provides that an “individual” and all members of his family described in IRC Section 318(a)(1) (i.e., his spouse, children, grandchildren, and parents) are treated as one individual for purposes of applying IRC Section 382 (which limits the amount of pre-change losses that a loss corporation may use to offset taxable income in the taxable years or periods following an ownership change)—applies solely from the perspective of individuals who are shareholders (as determined under applicable attribution rules) of the loss corporation. The court further held that siblings are not treated as one individual under IRC Section 382(l)(3)(A)(i).¹⁶ Accordingly, in Garber, the sale of shares by one brother to the other brother resulted in an ownership change with respect to the closely held corporation within the meaning of IRC Section 382(g).