Corporate Tax | Just Tax
Related Party Transactions (§ 267)
This checklist guides the analysis of transactions between related taxpayers under IRC § 267, covering loss disallowance, related party definitions, constructive ownership, indirect sales, gain offset, controlled group deferral, and the depreciable property rules of § 1239. Use this checklist whenever a client engages in any sale, exchange, loan, or expense arrangement with a related person, corporation, partnership, trust, or estate.
"No deduction shall be allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons specified in any of the paragraphs of subsection (b)." (IRC § 267(a)(1))
- The § 267(a)(1) loss disallowance rule and its exceptions.
- § 267(a)(1) disallows any deduction for loss from the sale or exchange of property, directly or indirectly, between persons described in § 267(b).
- The prohibition covers all transactions that fit the statutory language, regardless of the actual economic substance or the taxpayer's motivation.
- Exception for distributions in complete liquidation - the rule does not apply to distributions in complete liquidation of a corporation.
- § 267 is mandatory, not elective. If the parties are related and the transaction is a sale or exchange, the loss is disallowed. Period.
- § 267 applies to all losses regardless of character.
- The rule captures ordinary losses, capital losses, and § 1231 losses without distinction.
- Estate of Fusz v. Commissioner, 7 T.C. 718 (1946) - the court held that the scope of § 267 is broad and covers all character classes of loss.
- A practitioner cannot circumvent the rule by characterizing the loss as ordinary rather than capital.
- § 267 applies even to bona fide arm's-length transactions.
- Treas. Reg. § 1.267(a)-1(c) confirms that the relationship alone triggers the rule. No tax-avoidance motive is required.
- The disallowance is automatic once the related-party and sale-or-exchange elements are satisfied.
- If the transaction lacks economic substance or is not bona fide, no deduction is allowed even without § 267, but § 267 operates independently of those doctrines.
- CAUTION. The exclusivity misconception.
- Some practitioners assume that if § 267 does not apply, the loss is automatically allowed. This is wrong.
- If a transaction is not bona fide, courts will deny the loss on other grounds such as lack of economic substance or the sham transaction doctrine.
- § 267 is a floor, not a ceiling. It is one of multiple doctrines that may deny a related-party loss.
- § 267(b)(1). Family members.
- Covered persons include brothers and sisters (whether by whole or half blood), spouse, ancestors, and lineal descendants.
- Step-relatives, in-laws, cousins, nieces, and nephews are NOT covered.
- Rev. Rul. 71-50, 1971-1 C.B. 85 - an uncle and nephew are not related persons for § 267 purposes.
- If YES, the parties are family members under § 267(b)(1) → loss is disallowed under § 267(a)(1). If NO → proceed to test other paragraphs of § 267(b).
- § 267(b)(2). Individual and corporation (>50% stock ownership).
- An individual and a corporation are related if the individual owns directly or indirectly more than 50% in value of the corporation's outstanding stock.
- The threshold is strictly more than 50%. A 50% ownership stake does NOT trigger this paragraph.
- Indirect ownership is determined under § 267(c) constructive ownership rules.
- If YES → loss is disallowed. If NO → proceed to next paragraph.
- § 267(b)(3). Two corporations in the same controlled group.
- Two corporations are related if they are members of the same controlled group as defined in § 267(f).
- The controlled group definition uses a greater-than-50% threshold applied to stock ownership.
- The § 267(f) definition cross-references § 1563(a) with modifications.
- If YES → loss is disallowed unless an exception applies.
- § 267(b)(4) through § 267(b)(8). Trust and fiduciary relationships.
- § 267(b)(4) - grantor and fiduciary of the same trust (per se, no ownership threshold required).
- § 267(b)(5) - fiduciary of a trust and fiduciary of another trust, but only if the same grantor created both trusts.
- § 267(b)(6) - fiduciary of a trust and a beneficiary of the same trust (per se).
- § 267(b)(7) - fiduciary of a trust and beneficiary of another trust, but only if the same grantor.
- § 267(b)(8) - fiduciary of a trust and a corporation, but only if the trust or the grantor owns more than 50% in value of the corporation's stock.
- § 267(b)(9) through § 267(b)(11). Corporation, partnership, and S corporation pairings.
- § 267(b)(9) - a corporation and a partnership are related if the same persons own more than 50% in value of the corporation's stock AND more than 50% of the capital interest or profits interest in the partnership.
- § 267(b)(10) - two S corporations are related if the same persons own more than 50% in value of the stock of each corporation.
- § 267(b)(11) - an S corporation and a C corporation are related if the same persons own more than 50% in value of the stock of each corporation.
- Each of these paragraphs requires satisfaction of a dual >50% ownership test.
- § 267(b)(12) and § 267(b)(13). Estates and partnerships.
- § 267(b)(12) - an executor of an estate and a beneficiary of that estate are related, except for sales in satisfaction of a pecuniary bequest.
- § 267(b)(13) - two partnerships are related if the same persons own, directly or indirectly, more than 50% of the capital interest or profits interest in each partnership.
- The pecuniary bequest exception in § 267(b)(12) means that a sale to satisfy a specific dollar bequest does not trigger the disallowance.
- TRAP. Siblings and constructive ownership.
- Siblings are related persons under § 267(b)(1) - a brother and sister are directly related.
- However, stock ownership is NOT attributed between siblings under § 267(c)(2).
- A brother and sister are related, but stock owned by the sister is not constructively owned by the brother for purposes of the >50% ownership tests in § 267(b).
- This creates an asymmetry. Two siblings can transact without loss disallowance under § 267(b)(2) even if together they own 100% of a corporation, provided neither individually exceeds 50%.
"(1) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries. (2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family. (3) An individual owning (otherwise than by the application of paragraph (2)) stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner. (4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants. (5) Stock constructively owned by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person. Stock constructively owned by the individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock." (IRC § 267(c))
- § 267(c)(1). Entity-to-owner proportionate attribution.
- Stock owned by a corporation, partnership, estate, or trust is attributed proportionately to its shareholders, partners, or beneficiaries.
- This is downstream attribution only. Stock owned by a shareholder is NOT attributed upstream to the corporation.
- There is no minimum ownership threshold for this attribution to apply.
- The attribution is based on the proportionate beneficial interest of each owner in the entity.
- § 267(c)(2). Family attribution.
- An individual is treated as constructively owning stock that is actually owned by family members.
- Family for this purpose is defined in § 267(c)(4) as brothers and sisters (whole or half blood), spouse, ancestors, and lineal descendants.
- This is a broad attribution rule that can cause an individual to be treated as owning stock held by multiple family members.
- The constructive ownership is used to test the >50% thresholds in § 267(b)(2) and similar paragraphs.
- § 267(c)(3). Partner attribution.
- An individual who actually owns stock in a corporation is treated as constructively owning stock held by his partner.
- This attribution requires the individual to already actually own stock in the corporation. The individual cannot rely solely on family-attributed stock to trigger partner attribution.
- If an individual owns no stock directly, and only constructively through family, the partner attribution rule does not apply.
- This is a narrower rule than the family attribution rule and requires actual stock ownership as a predicate.
- § 267(c)(5). The reattribution prohibition.
- Stock constructively owned under § 267(c)(1) (entity-to-owner) CAN be reattributed. If a partnership owns stock, it is attributed to the partner, and that constructively owned stock can then be attributed under § 267(c)(2) to the partner's family members.
- Stock constructively owned under § 267(c)(2) (family attribution) CANNOT be reattributed. If a wife owns stock attributed to her husband, that stock cannot be reattributed from the husband to his brother.
- Stock constructively owned under § 267(c)(3) (partner attribution) CANNOT be reattributed.
- This limitation prevents endless chains of constructive ownership and limits the reach of § 267(c)(2).
- Critical differences from § 318 constructive ownership.
- § 267(c) has NO corporation-to-shareholder upstream attribution. § 318(a)(2)(B) provides upward attribution from a 50%-owned corporation.
- § 267(c) has NO option attribution. § 318(a)(4) treats a person holding an option to acquire stock as owning that stock.
- § 267(c) generally has NO reattribution of family-attributed stock. § 318(a)(5)(A) permits broader reattribution.
- These differences mean § 267(c) is narrower than § 318 in important respects. Always verify which constructive ownership regime applies to the provision at issue.
- Hickman v. Commissioner, T.C. Memo. 1972-208.
- The Tax Court held that proportionate attribution under § 267(c)(1) is based on fair market value, not actuarial methods.
- The court rejected the IRS argument that actuarial life expectancy tables should be used to determine a beneficiary's proportionate interest in an estate.
- Attribution is based on the value of the beneficial interest at the relevant time.
- McWilliams v. Commissioner, 331 U.S. 694 (1947).
- The Supreme Court held that a husband's direction to his broker to sell stock from the husband's account and simultaneously purchase the same stock in the wife's account constituted an indirect sale between related parties.
- The husband realized the loss but the wife acquired the identical stock at the same time through the same broker.
- The Court found this was a single coordinated transaction, not two independent trades.
- The husband's loss was disallowed under § 267(a)(1) because the sale and purchase were indirect transactions between related persons.
- United States v. Norton, 250 F.2d 902 (5th Cir. 1958).
- The Fifth Circuit held that a 28-day gap between the taxpayer's sale of stock and a related party's purchase of the same stock broke the chain of connection.
- The court found the transactions were independent and NOT an indirect sale under § 267(a)(1).
- This case establishes that temporal separation can defeat the indirect sale characterization.
- The length of the gap and the surrounding circumstances are critical facts in the analysis.
- The temporal proximity and plan-of-action test.
- Courts look at whether the sale and repurchase were part of a unified plan or prearranged scheme.
- Factors include simultaneity of execution, use of the same broker, communication between the parties, the type of property, and whether the repurchaser had an independent reason to acquire the property.
- If there was a prearranged plan for the related party to acquire the property, the step-transaction doctrine may collapse the separate steps into a single indirect sale.
- If the transactions were independent, with no plan or coordination, the loss may be allowed.
- CAUTION. The undefined boundary between indirect and independent transactions.
- Simultaneous sale and repurchase through a coordinated order = definitely an indirect sale.
- A gap of 28 days with no plan of repurchase = probably safe based on Norton.
- Between those poles, the risk of recharacterization increases as temporal proximity increases and as evidence of a plan accumulates.
- Practitioners should document the independence of any sale to an unrelated party followed by a related-party purchase.
- Higgins v. Smith, 308 U.S. 473 (1940).
- The Supreme Court held that a taxpayer realizes no deductible loss on a sale of property to a wholly owned corporation.
- The Court characterized the transaction as moving assets "from one pocket to another."
- The corporation was the taxpayer's alter ego for this purpose.
- This case reinforces the core policy of § 267 - losses within an economic family do not reflect true economic detriment.
- Lakeside Irrigation Co. v. Commissioner, 128 F.2d 418 (5th Cir. 1942).
- The Fifth Circuit held that when a taxpayer sells multiple properties to a related party in a single transaction, gains and losses on the separate properties cannot be netted against each other.
- Each property's gain or loss must be computed and reported separately.
- Gains on individual properties are fully recognized and taxable.
- Losses on individual properties are disallowed under § 267(a)(1) and provide no offset.
- Morris Investment Corp. v. Commissioner, 156 F.2d 748 (3d Cir. 1946).
- The Third Circuit confirmed the nonaggregation rule established in Lakeside Irrigation.
- The court rejected the taxpayer's argument that the single-transaction form should permit netting of gains and losses across all properties.
- The rule applies regardless of whether the properties are of the same or different character.
- This judicial consensus across circuits makes the nonaggregation rule well-settled law.
- Rev. Rul. 76-377, 1976-2 C.B. 110.
- The IRS adopted the judicial nonaggregation rule administratively.
- The ruling confirms that the Service will follow Lakeside Irrigation and Morris Investment Corp. in examining returns.
- A taxpayer who nets gains and losses on a related-party multi-asset sale will face an adjustment upon examination.
- The ruling applies to all taxpayers, not just those in the Fifth or Third Circuits.
- EXAMPLE. Multi-property sale to a related corporation.
- Taxpayer sells Property A (realized gain of $10,000) and Property B (realized loss of $8,000) to his 100% owned corporation in a single transaction.
- Under the nonaggregation rule, the $10,000 gain on Property A is fully recognized and included in gross income.
- The $8,000 loss on Property B is disallowed under § 267(a)(1) and provides no tax benefit.
- Taxpayer cannot net the two. Total recognized gain is $10,000. The $8,000 loss disappears permanently unless a subsequent event creates offset potential under § 267(d).
- A foreclosure surrender to a mortgagee is not a sale or exchange.
- J.P. Carlton v. Commissioner, 10 T.C. 924 (1948) - the Tax Court held that a mortgagor's surrender of property to a mortgagee in foreclosure proceedings does not constitute a sale or exchange.
- The transaction lacked the mutual assent and bargained-for-exchange elements of a sale.
- Because there was no sale or exchange, § 267(a)(1) did not apply to disallow the loss.
- If the transaction is structured as a deed in lieu of foreclosure without consideration, § 267(a)(1) does not apply even if the mortgagee is a related party.
- An involuntary conversion is not an exchange for § 267 purposes.
- E.H. Swain v. Commissioner, T.C. Memo. 1976-234 - the court held that an involuntary conversion does not qualify as an exchange under § 267(a)(1).
- The taking of property by governmental authority through eminent domain or similar action is not a voluntary sale or exchange between the parties.
- § 267(a)(1) requires a voluntary transactional form - a sale or exchange - not a forced transfer.
- If the client faces an involuntary conversion to a related party, the loss may still be disallowed on other grounds but § 267(a)(1) does not automatically apply.
- A pure gift is not a sale or exchange.
- A direct gift of property to a related party does not trigger § 267(a)(1) because a gift lacks the element of consideration that defines a sale or exchange.
- The donee takes a carryover basis under § 1015, so the built-in loss is preserved in the donee's hands.
- However, § 267(d) does NOT apply to donees. The § 267(d) offset rule only applies when the related party acquires property in a sale or exchange. A donee is not within § 267(d).
- If the gift is part of a larger transaction with reciprocal consideration, substance-over-form analysis may recharacterize the transaction as a disguised sale.
- TRAP. The gift loophole and its limits.
- A client might consider gifting loss property to a related party to avoid § 267(a)(1) disallowance. This works at the first level because a gift is not a sale or exchange.
- But the donee receives carryover basis under § 1015(a) and cannot use § 267(d) to offset gain on a later sale because § 267(d) requires a prior "sale or exchange."
- If the donee later sells the property at a gain, the full gain is recognized with no offset for the donor's disallowed loss.
- Substance-over-form doctrine may apply if the "gift" is actually part of a coordinated arrangement with reciprocal benefits.
"If property is acquired by a related person in a transaction with respect to which loss is not allowable under subsection (a)(1), and such person thereafter sells or otherwise disposes of such property at a gain, then, except as provided in paragraph (2), such gain shall be recognized only to the extent that such gain exceeds the loss from the first transaction which was not allowed as a deduction under subsection (a)(1)." (IRC § 267(d)(1)(A))
- The offset mechanics. If the related party purchaser later sells the property at a gain, the recognized gain equals the realized gain reduced by the previously disallowed loss, but not below zero. (§ 267(d)(1)(A) and (B))
- The disallowed loss from the first transaction functions as a permanent shield against gain on the subsequent disposition.
- Gain recognized in excess of the disallowed loss amount retains its original character as determined under general tax principles.
- No time limitation on the subsequent sale. The subsequent sale to an unrelated party may occur in any future taxable year, including many years after the original related party transaction. (Treas. Reg. § 1.267(d)-1(a)(1))
- The offset survives indefinitely until the property is sold at a gain to an unrelated party.
- If the related party transfers the property in a nonrecognition transaction before the taxable sale, § 267(d) continues to apply to the substituted basis property. (Treas. Reg. § 1.267(d)-1(b))
- No application to losses on the subsequent sale. If the subsequent sale produces a loss, the previously disallowed loss from the original related party transaction is lost forever and can never be recognized. (Treas. Reg. § 1.267(d)-1(a)(3))
- The disallowed loss does not become available in a later taxable year.
- The transferee simply recognizes the realized loss on the subsequent sale subject to general loss limitation rules.
- No basis adjustment under § 267(d). The related party purchaser's basis in the property remains cost basis (the amount paid in the original related party transaction). (Treas. Reg. § 1.267(d)-1(c)(1))
- The realized gain on the subsequent sale is computed using this unadjusted cost basis.
- § 267(d)(1)(B) increases basis for purposes of determining recognized gain only, not for computing realized gain or depreciation.
- Transferee scope limitation. § 267(d) applies only to the original transferee who acquired by purchase or exchange. It does not apply to donees or persons acquiring property by inheritance or gift. (Treas. Reg. § 1.267(d)-1(a)(3))
- A transferee taking property with a basis determined under § 1014 (inheritance) cannot claim the offset.
- A donee taking property with carryover basis under § 1015 likewise cannot claim the offset.
- § 267(d)(2) wash sale exception. § 267(d) does not apply if the transferor's loss was disallowed under § 1091 (wash sales). (§ 267(d)(2))
- If the related party sale and repurchase triggers § 1091, the § 267(d) gain offset mechanism is unavailable.
- Determine which loss disallowance provision applies and proceed under the applicable rule.
- § 267(d)(3) tax-indifferent party exception (PATH Act 2015). § 267(d) does not apply to the extent the transferor's loss would not have been taken into account in determining US income tax liability. (§ 267(d)(3))
- This prevents a domestic taxpayer from benefiting from a loss that a tax-exempt or foreign transferor could not have used.
- The provision applies to transfers after December 18, 2015.
- EXAMPLE. Individual A sells property with a $100,000 adjusted basis to his 100% owned corporation C for $70,000. The $30,000 realized loss is disallowed under § 267(a)(1). C's basis is $70,000. C later sells the property to unrelated buyer X for $110,000. C's realized gain is $40,000 ($110,000 amount realized minus $70,000 basis). Under § 267(d), C's recognized gain is $10,000 ($40,000 realized gain minus $30,000 previously disallowed loss).
- EXAMPLE (loss scenario). Same facts except C sells to unrelated X for $60,000. C's realized loss is $10,000 ($60,000 minus $70,000 basis). The $30,000 loss disallowed to A is NEVER recognized by any party. C recognizes a $10,000 loss under general principles.
- The § 267(a)(2) extension to partnerships. § 267(e)(1) extends the § 267(a)(2) matching rule to transactions between a partnership and a person related to any partner. (§ 267(e)(1))
- The matching deferral applies to payments made by a partnership to a related party of any partner.
- It also applies to payments made to a partnership by a related party of any partner.
- Covered entities. § 267(e)(1)(A) covers the pass-through entity itself, including partnerships and S corporations. § 267(e)(1)(B) covers any owner of any capital or profits interest in the entity. (§ 267(e)(1)(A) and (B))
- The entity and any owner are treated as the payor or payee for matching purposes.
- This expands the related party net beyond direct § 267(b) relationships.
- Person related to a partner. § 267(e)(2) provides that "person related to a partner" includes any person bearing a § 267(b) relationship to any partner. (§ 267(e)(2))
- If Partner P's sibling S receives a payment from P's partnership, the § 267(a)(2) matching rule applies.
- This creates a broad web of potential deferrals reaching beyond the partnership structure itself.
- § 267(e)(3) constructive ownership rules for partnerships. § 267(e)(3) provides special constructive ownership rules that differ from the standard § 267(c) attribution rules. (§ 267(e)(3))
- A partner is considered as owning stock owned directly or indirectly by or for the partnership in proportion to the partner's capital or profits interest.
- This attribution can create § 267(b) relationships that would not exist under direct ownership alone.
- § 267(e)(4) guaranteed payments exception. Guaranteed payments under § 707(c) are excepted from the § 267(a)(2) matching rule. (§ 267(e)(4))
- A partnership may deduct guaranteed payments in the year of accrual regardless of when the partner includes the payment in income.
- This exception applies only to payments meeting the § 707(c) definition of guaranteed payments.
- § 267(e)(5) low-income housing exception. § 267(e)(5) provides a special exception for certain low-income housing tax credit partnerships. (§ 267(e)(5))
- This exception prevents the matching rule from interfering with the economic structure of tax credit deals.
- The exception applies only to partnerships meeting the specific statutory requirements.
- § 267(e)(6) cross-reference to § 707(b). § 267(e)(6) provides that § 267(e) does not apply to losses on transactions described in § 707(b), which has its own related party loss disallowance rules. (§ 267(e)(6))
- If a transaction falls within § 707(b)(1) or (b)(2), apply § 707(b) rather than § 267(e).
- § 707(b)(1) requires a more-than-50% capital or profits interest for loss disallowance.
- CAUTION. § 267(e) applies the § 267(a)(2) matching rule to ANY partner interest, no matter how small. There is no greater-than-50% threshold. This scope is significantly broader than § 707(b)(1), which applies only to partners owning more than 50% of capital or profits interests.
"For purposes of this section, the term 'controlled group' has the meaning given to such term by section 1563(a), except that, in applying subsection (a)(1) and (a)(2) of section 1563 for purposes of this section, the phrase 'more than 50 percent' shall be substituted for the phrase 'at least 80 percent' each place it appears in such subsections." (IRC § 267(f)(1))
"In the case of any sale or exchange of property between members of the same controlled group, losses from the sale or exchange shall be deferred rather than disallowed." (IRC § 267(f)(2))
- The controlled group definition. § 267(f)(1) defines controlled group using § 1563(a) but with a critical modification. (§ 267(f)(1))
- The threshold is "more than 50%" rather than the "at least 80%" standard used in § 1563(a).
- § 1563(a)(4) (parent-subsidiary chains) and § 1563(e)(3)(C) (certain option attribution rules) are excluded for this purpose.
- Deferred rather than disallowed. § 267(f)(2) provides that losses on sales or exchanges between controlled group members are DEFERRED, not permanently disallowed. (§ 267(f)(2))
- The loss remains available and will be recognized when a triggering event occurs.
- This is a critical distinction from § 267(a)(1), which produces a permanent loss disallowance.
- Triggering events under § 267(f). The deferred loss is recognized when the property leaves the controlled group. (Treas. Reg. § 1.267(f)-1(c)(1)(iii)-(iv))
- If the buyer corporation sells the property to an unrelated party, the deferred loss triggers.
- If the buyer corporation is no longer a member of the controlled group and still holds the property, the deferred loss triggers at that time.
- Critical difference from consolidated return rules. Under § 1.1502-13, deferred intercompany loss triggers when the buyer, seller, OR asset leaves the consolidated group. Under § 267(f), loss generally triggers only when the ASSET leaves the controlled group. (Treas. Reg. § 1.267(f)-1(c)(1)(iii)-(iv))
- If the selling member leaves the controlled group while the buyer retains the property, the § 267(f) deferred loss does NOT automatically trigger.
- This creates a potential permanent trap if the seller departs and the asset never leaves the group.
- Character and source of deferred loss. Treas. Reg. § 1.267(f)-1 adopts timing principles from § 1.1502-13 but does NOT adopt attribute redetermination. (Treas. Reg. § 1.267(f)-1(c)(3))
- The character and source of the deferred loss are determined at the time of the original intercompany transaction.
- Changes in the taxpayer's circumstances between the deferral year and the recognition year do not alter the character or source of the deferred loss.
- § 267(f)(3) special entity and property rules. § 267(f)(3) provides special rules for DISCs, inventory property, and foreign currency denominated loans. (§ 267(f)(3))
- Loss deferral treatment may differ for these specific categories of transactions.
- If the transaction involves a DISC or foreign currency loans, consult the specific statutory rules and applicable regulations.
- § 267(f)(4) deferral treated as disallowance for cross-references. For purposes of cross-references to other Code sections, the § 267(f) deferral is treated as a disallowance. (§ 267(f)(4))
- This coordination rule affects the interaction with other provisions that reference § 267(a)(1).
- The loss is deferred for timing purposes but functions as disallowed for purposes of other statutory references.
- EXAMPLE. Parent P owns all of the stock of subsidiary S and subsidiary B. S sells property with an $80,000 adjusted basis to B for $60,000. The $20,000 realized loss is DEFERRED under § 267(f)(2), not disallowed under § 267(a)(1). Two years later, B sells the property to unrelated X for $75,000. At that point, S recognizes the $20,000 deferred loss (determined at the time of the original S-to-B sale). B recognizes $15,000 of gain ($75,000 amount realized minus $60,000 basis).
"In the case of a sale or exchange of property, directly or indirectly, between related persons, any gain recognized to the transferor from the transfer of property which, in the hands of the transferee, is property of a character which is subject to the allowance for depreciation under section 167 shall be treated as ordinary income." (IRC § 1239(a))
- Ordinary income treatment for the entire gain. Gain on the sale or exchange of depreciable property between related persons is treated as ordinary income, not capital gain. (§ 1239(a))
- The ENTIRE gain is ordinary income, not merely the depreciation recapture amount.
- This treatment is broader than §§ 1245 and 1250, which convert only a portion of gain to ordinary income.
- The transferee-use test for depreciable property. § 1239 applies to property "of a character which is subject to the allowance for depreciation provided in section 167" IN THE HANDS OF THE TRANSFEREE. (§ 1239(a))
- The transferor's use of the property is completely irrelevant to the § 1239 analysis.
- If the transferee intends to hold the property for personal use or for sale to customers, § 1239 may not apply even if the transferor previously depreciated the property.
- TRAP. The transferor's characterization of the property is irrelevant. Only the transferee's intended use determines whether § 1239 applies. A transferor who used property as a capital asset may find the entire gain recharacterized as ordinary income if the transferee will depreciate it.
- Related persons for § 1239 purposes. § 1239(b) defines related persons more narrowly than § 267(b). (§ 1239(b))
- A taxpayer and all entities controlled by the taxpayer (more than 50% ownership by vote or value).
- A taxpayer and a trust beneficiary, unless the beneficiary's interest is a remote contingent interest.
- An executor of an estate and a beneficiary of the estate, except in the case of a pecuniary bequest.
- § 1239 applies to § 1231 property. § 1239 overrides the favorable § 1231 treatment and converts otherwise-eligible capital gain into ordinary income. (§ 1239(a))
- Property that is § 1231 property in the transferor's hands becomes ordinary income property if it is depreciable in the transferee's hands.
- The § 1231 lookback rule does not prevent this recharacterization.
- § 453(g) installment method prohibition. § 453(g) specifically prohibits the use of the installment method for § 1239 transactions. (§ 453(g))
- The transferor must recognize the full ordinary income gain in the year of sale, even if payment is received over multiple years.
- This accelerates income recognition and eliminates the time-value-of-money benefit of installment reporting.
- Application to § 351 transactions. § 1239 applies to boot gain recognized in § 351 transfers.
- Easson v. Commissioner, 33 T.C. 963 (1960) held that § 1239 applies to gain recognized on the transfer of depreciable property to a controlled corporation under § 351.
- Rev. Rul. 60-302, 1960-2 C.B. 211 held that § 1239 applies to gain recognized under § 351(b) (receipt of boot) and § 357(c) (liability in excess of basis) on transfers of depreciable property.
- Indirect transactions. § 1239 applies to indirect sales or exchanges between related persons, not merely direct transfers. (§ 1239(a))
- A sale to an unrelated party who immediately transfers the property to a related person may be treated as an indirect related party transaction.
- Examine the overall transaction structure to determine whether the transferor effectively sold to a related party through an intermediary.
"If (A) there is a payment by a person which is allowable as a deduction under this chapter to such person, and (B) an amount attributable to such payment is not includible in the gross income of a payee who is a related person by reason of subsection (b) or subsection (e)(4)(C), then no deduction shall be allowable under this chapter to such person for such payment until such amount is includible in the gross income of such payee." (IRC § 267(a)(2))
- The matching principle. If the payor uses the accrual method of accounting and the payee uses the cash method (or otherwise does not include the amount in gross income until paid), the payor's deduction is deferred until the amount is includible in the payee's gross income. (§ 267(a)(2))
- The payor and payee must be related persons under § 267(b) or § 267(e)(4)(C).
- The payment must be of a type that would be deductible by the payor under general principles.
- Covered payments. § 267(a)(2) applies to interest, salaries, compensation for services, rents, royalties, and other deductible expenses. (§ 267(a)(2))
- Any accrual by the payor that produces a deduction is subject to potential deferral.
- This includes recurring expenses as well as one-time payments.
- The same taxable year requirement. The payor's deduction and the payee's income inclusion must occur in the same taxable year for the matching principle to be satisfied. (§ 267(a)(2))
- If the payee includes the amount in Year 2 and the payor originally accrued in Year 1, the payor deducts in Year 2.
- If the payee never includes the amount in income, the payor may never receive the deduction.
- Tax-exempt payee exception. If the payee is a tax-exempt entity under § 501(a), no deferral is required because the amount is never includible in the payee's gross income. (§ 267(a)(2)(B))
- The payor may deduct the payment in the year of accrual.
- This exception applies because the statutory predicate for deferral, the payee's income inclusion, can never occur.
- Foreign payee considerations. If the payee is a foreign person not subject to US income tax, deferral may apply or may be permanent depending on treaty and sourcing rules. (§ 267(a)(2)(B))
- If the foreign payee is not required to include the payment in US gross income, the accrual-method payor's deduction is deferred.
- This can produce a permanent deferral if the foreign payee is never subject to US tax on the payment.
- Planning through accounting method changes. A payor or payee may consider changing accounting methods to align both parties on the accrual method, thereby eliminating the § 267(a)(2) mismatch. (Treas. Reg. § 1.267(a)-1)
- A change in accounting method generally requires the consent of the Commissioner.
- The § 481(a) adjustment may produce undesirable income or deduction timing consequences.
- EXAMPLE. Accrual-method corporation C owes $50,000 of salary to its greater-than-50% shareholder-CEO, Individual A, who uses the cash method. C accrues the $50,000 salary expense in Year 1 but pays A in Year 2. A includes the $50,000 in gross income in Year 2 (when received). C deducts the $50,000 in Year 2, not Year 1. The deduction is deferred until A includes the amount in income.
- Cash method required for interest to related foreign persons. § 267(a)(3) provides that interest expense owed to a related foreign person is deductible only when PAID, regardless of the payor's overall accounting method. (§ 267(a)(3))
- An accrual-method taxpayer must defer the interest deduction until the year of actual payment.
- This overrides the taxpayer's normal method of accounting for interest expense.
- Covered related foreign persons. "Related foreign person" includes controlled foreign corporations (CFCs), foreign partnerships, and other foreign entities that meet § 267(b) or § 267(e) relationship tests. (§ 267(a)(3))
- Determine related party status under § 267(b) using § 267(c) constructive ownership rules.
- Attribution through foreign entities may create related party status that would not exist under direct ownership analysis.
- § 267(a)(3)(B) special rule for CFCs and PFICs. § 267(a)(3)(B) provides special rules applicable to interest paid to CFCs and passive foreign investment companies (PFICs). (§ 267(a)(3)(B))
- The deferral applies to interest that would otherwise be currently deductible under the payor's method of accounting.
- Coordination with subpart F and PFIC income inclusion rules may affect the timing analysis.
- Interaction with § 1441 and § 1442 withholding. Interest payments to foreign persons are generally subject to 30% federal withholding tax, unless reduced by an applicable income tax treaty. (§§ 1441 and 1442)
- The withholding obligation arises at the time of payment, which coincides with the deduction timing under § 267(a)(3).
- A treaty rate reduction does not override the § 267(a)(3) deduction deferral. (Tate & Lyle v. Commissioner, 87 F.3d 99 (3d Cir. 1996))
- Required forms. The withholding agent must file Form 1042 (Annual Withholding Tax Return for US Source Income of Foreign Persons) and Form 1042-S (Foreign Person's US Source Income Subject to Withholding). (Treas. Reg. § 1.1461-1)
- These forms report the interest payment and any withholding to the IRS and the foreign payee.
- Failure to file may result in penalties under § 6651 and potential liability for the withholding tax under § 1461.
- Judicial authority on § 267(a)(3). Courts have consistently upheld the deduction deferral for interest paid to related foreign persons.
- Square D Co. v. Commissioner, 118 T.C. 299 (2002) held that an accrual-method US subsidiary must defer its interest deduction on indebtedness to its foreign parent corporation until the year of actual payment, applying § 267(a)(3) notwithstanding the subsidiary's overall accrual method.
- Tate & Lyle v. Commissioner, 87 F.3d 99 (3d Cir. 1996) held that an income tax treaty exemption from withholding tax on interest payments does not override the § 267(a)(3) deduction timing deferral. The treaty addresses the foreign payee's income taxation, not the US payor's deduction timing.
- CAUTION. Both § 267(a)(3) and § 267A (hybrid mismatch arrangements) may apply to the same interest payment to a related foreign person. § 267(a)(3) is a timing deferral only. § 267A may produce a PERMANENT disallowance if the payment is made pursuant to a hybrid mismatch arrangement. Analyze both provisions independently.
"The Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." (IRC § 482)
- § 482 scope and operative standard. The Secretary may reallocate income, deductions, credits, or allowances among controlled taxpayers whenever necessary to prevent tax evasion or to clearly reflect income (§ 482).
- The statute applies to taxpayers "whether or not incorporated, whether or not organized in the United States, and whether or not affiliated" (§ 482).
- Reallocation requires the IRS to determine an arm's-length result using methods prescribed in Treas. Reg. § 1.482-1 through § 1.482-9.
- The IRS bears the burden of proving that a reallocation is necessary under § 482.
- Relationship between § 482 and § 267. Both sections may apply to the same transaction without conflict.
- § 482 operates as a reallocation tool that adjusts results to reflect arm's-length terms.
- § 267 operates as a bright-line disallowance or deferral rule that triggers automatically upon a related party transaction.
- A transaction that avoids § 267 through technical structuring may still be reallocated under § 482 if it lacks arm's-length pricing.
- Decision framework for concurrent application. If the transaction involves controlled taxpayers and lacks arm's-length pricing → § 482 reallocation may apply in addition to any § 267 disallowance or deferral. If the transaction is at arm's-length → § 482 does not apply but § 267 may still apply on its own terms.
- Imputed interest mechanism for related party loans. Forgone interest on a below-market loan between related parties is treated as a deemed transfer from lender to borrower followed by a retransfer of interest income from borrower back to lender (§ 7872(a), (b)).
- The deemed transfer is characterized as a gift, dividend, or compensation payment depending on the relationship between the parties (§ 7872(c)).
- The lender recognizes imputed interest income equal to the excess of the applicable Federal rate (AFR) over the stated interest rate (§ 7872(a)(1)).
- The AFR is set monthly by the IRS under § 1274(d)(1) and varies by loan term (short-term, mid-term, or long-term).
- De minimis and capped exceptions. Two exceptions limit the § 7872 imputation for small gift loans.
- Gift loans of $10,000 or less are entirely exempt from § 7872 if the loan proceeds are not used to purchase income-producing property (§ 7872(c)(2)).
- For gift loans of $100,000 or less, the imputed interest is capped at the borrower's net investment income for the taxable year (§ 7872(d)(1)). If the borrower has net investment income of zero or less, no interest is imputed.
- § 7872 and § 267 independence. § 7872 and § 267 operate independently and may both apply to the same loan transaction.
- A below-market loan between § 267 related parties triggers both the § 7872 imputed interest rules and any applicable § 267 disallowance or deferral.
- The § 7872 imputation does not alter the character of the underlying transaction for § 267 purposes.
- § 707(b)(1) loss disallowance. No deduction is allowed for any loss from a sale or exchange of property between a partnership and a person owning more than 50 percent of the capital interest or profits interest in the partnership (§ 707(b)(1)(A)).
- The disallowance also applies to sales between two partnerships if the same persons own more than 50 percent of the capital or profits interests in each partnership (§ 707(b)(1)(B)).
- The more-than-50-percent threshold mirrors the § 267(b)(2) corporate shareholder test but applies to partnership interests.
- § 707(b)(2) ordinary income conversion. Any gain recognized on a sale to which § 707(b)(1) applies is treated as ordinary income if the property is not a capital asset in the hands of the transferee (§ 707(b)(2)).
- This rule parallels § 1239 but applies specifically to partnership transactions.
- If the transferee partnership will hold the property as inventory or other non-capital asset → the transferor's entire gain is ordinary.
- Constructive ownership for § 707(b). § 267(c) applies for determining ownership under § 707(b) except that § 267(c)(3) does not apply (§ 707(b)(3)).
- Stock ownership is attributed from corporations to shareholders under § 267(c)(1) and from shareholders to corporations under § 267(c)(2).
- Family attribution under § 267(c)(2) applies but entity attribution under § 267(c)(3) does not.
- Complementary scope with § 267(e). § 707(b) applies to property sales between partners and partnerships. § 267(e) applies to expense and interest matching within a controlled group.
- A single transaction may implicate § 707(b) for loss disallowance and § 267(e) for deduction matching.
- Analyze each provision separately because the ownership tests and transaction coverage differ.
- § 336(d)(1) related party distribution losses. No loss is recognized by a corporation on the distribution of property to a related person if the distribution is either non-pro-rata or involves disqualified property (§ 336(d)(1)(A)).
- A related person for this purpose is determined under § 267(b) using a more-than-50-percent threshold (§ 336(d)(1)(B)).
- Disqualified property means any property which is acquired by the liquidating corporation in a § 351 exchange or as a capital contribution during the 5-year period ending on the date of distribution (§ 336(d)(1)(B)).
- § 336(d)(2) anti-stuffing rule. The basis of property acquired by a corporation is reduced by the amount of any built-in loss existing at the time of acquisition if the corporation acquires the property with a view to recognizing the loss in a subsequent distribution or sale (§ 336(d)(2)).
- A 2-year presumption applies. Property acquired within 2 years of a plan of complete liquidation is presumed acquired with a tax-avoidance purpose (§ 336(d)(2)).
- The reduction applies only to the extent of the built-in loss at the time of acquisition.
- § 336(d) and § 267 coordination. The § 336(d) rules supplement § 267 by targeting specific liquidation-related loss strategies.
- A distribution to a § 267 related party in a complete liquidation may trigger both § 336(d)(1) and § 267(a)(1).
- The § 336(d)(2) basis reduction operates independently of § 267 but achieves a similar policy result of preventing related party loss recognition.
- § 267A permanent deduction disallowance. No deduction is allowed for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by or to a hybrid entity (§ 267A(a)).
- A disqualified related party amount is any interest or royalty paid or accrued to a related party if there is a corresponding deduction or other tax benefit in the related party's foreign country (§ 267A(b)).
- A hybrid entity is any entity that is treated as fiscally transparent for one country's tax purposes but not for the other country's tax purposes (§ 267A(b)(3)).
- Final regulations under T.D. 9896, 85 Fed. Reg. 19854 (Apr. 8, 2020), provide detailed guidance on hybrid mismatch arrangements.
- Relationship to § 267(a)(3) timing deferral. § 267A and § 267(a)(3) may both apply to the same related party payment but produce different consequences.
- § 267A produces a permanent disallowance of the deduction. The deduction is never recovered.
- § 267(a)(3) produces a timing deferral. The deduction is postponed until economic performance and payment occur.
- If both provisions apply → the § 267A permanent disallowance governs and supersedes the § 267(a)(3) deferral for the same amount.
- Effective date and coverage. § 267A applies to tax years beginning after December 31, 2017 (Pub. L. 115-97, § 14221(c)).
- The provision was enacted as part of the Tax Cuts and Jobs Act of 2017.
- It targets cross-border base erosion through related party interest and royalty payments.
- § 118 contribution-to-capital nonrecognition. § 118 excludes from gross income any contribution to the capital of a corporation (§ 118(a)).
- A contribution to capital by a § 267 related party is governed by § 118 rather than § 267 because no sale or exchange occurs.
- The corporation's basis in contributed property is determined under § 362(a)(2) and is not limited by § 267.
- If a purported contribution is recharacterized as a disguised sale → § 267 may apply to the sale component.
- § 162 trade or business expense requirements. Expenses paid to a related party must satisfy § 162 even if § 267 deferral does not apply.
- An expense must be ordinary and necessary and paid or incurred during the taxable year in carrying on a trade or business (§ 162(a)).
- § 267 defers the timing of deduction but does not create a deduction where § 162 is not satisfied.
- If an expense is unreasonable in amount → the IRS may challenge the excess under § 162(a)(1) or reallocate under § 482.
"The question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended." (Gregory v. Helvering, 293 U.S. 465 (1935))
- Three alternative tests for integrated treatment. The IRS may collapse a series of formally separate but interrelated transactions into a single integrated transaction if any one of three tests is satisfied.
- The binding commitment test requires that at the time of the first step the parties were contractually bound to complete all subsequent steps (Commissioner v. Clark, 489 U.S. 726, 738 (1989) (binding commitment test established for corporate reorganization step transactions)).
- The mutual interdependence test treats steps as a single transaction when the steps are so interdependent that the legal relations created by one transaction would have been fruitless without the completion of the series (Penrod v. Commissioner, T.C. Memo. 1994-220 (mutual interdependence applied to deny claimed tax benefits)).
- The end result test collapses separate steps when they are prearranged parts of a single transaction intended from the outset to reach a particular result (Esmark, Inc. v. Commissioner, 90 T.C. 171 (1988), aff'd, 886 F.2d 1318 (7th Cir. 1989) (series of stock redemptions treated as integrated under end result test)).
- Related party application. The step-transaction doctrine is particularly potent in related party contexts because related parties can easily structure multi-step transactions.
- McWilliams v. Commissioner, 331 U.S. 694 (1947) (applied step-transaction-like analysis to a simultaneous sale and repurchase between related parties to prevent tax avoidance).
- A taxpayer who structures a sale through an unrelated intermediary to avoid § 267(b) may find the steps collapsed and the loss disallowed.
- If the steps are interdependent and serve no independent business purpose → treat as a single related party transaction for § 267 purposes.
- IRS authority to look through legal form. The IRS may recharacterize a transaction based on its economic reality rather than the labels the parties assign.
- Gregory v. Helvering, 293 U.S. 465 (1935) (a transaction must have substance beyond tax motive to receive the intended tax treatment).
- The doctrine applies with full force to related party transactions because related parties have greater ability to manipulate form.
- A transaction structured as an arm's-length sale to an unrelated party may be recharacterized as a related party transaction if the unrelated party is merely an agent or conduit.
- Impact on § 267 analysis. Substance-over-form analysis can defeat attempts to avoid § 267 through formalistic structuring.
- If the economic substance of a transaction is a sale between related parties → § 267 applies regardless of the formal structure.
- The IRS may recharacterize a loan as an equity contribution, a sale as a gift, or an independent transaction as an agency arrangement.
- Even if § 267 does not technically apply → substance-over-form may produce the same disallowance result.
- Statutory two-prong test under § 7701(o). A transaction has economic substance only if both prongs are satisfied (§ 7701(o)(1)).
- Prong A requires that the transaction changes in a meaningful way the taxpayer's economic position apart from Federal income tax effects (§ 7701(o)(1)(A)).
- Prong B requires that the taxpayer has a substantial purpose apart from Federal income tax effects for entering into the transaction (§ 7701(o)(1)(B)).
- Both prongs must be satisfied. Failure of either prong means the transaction lacks economic substance.
- Consequences and related party application. If a transaction lacks economic substance → the IRS may disregard the transaction in its entirety.
- Rev. Rul. 2024-14, 2024-33 I.R.B. 1 (IRS applies economic substance doctrine to related-party partnership basis adjustments involving consolidated groups).
- The doctrine does not require the IRS to prove tax evasion intent. The mechanical two-prong test controls.
- Related party transactions that lack non-tax economic effects are at high risk of challenge under § 7701(o).
- Transactions disregarded for total lack of economic effects. A transaction that lacks any economic substance beyond tax benefits may be disregarded entirely.
- Kirchman v. Commissioner, 862 F.2d 1486 (11th Cir. 1989) ("A transaction ceases to merit tax respect when it has no economic effects other than creation of tax benefits").
- The sham transaction doctrine is the most aggressive judicial tool and may apply even if the transaction satisfies § 7701(o) but is found to be a sham on its facts.
- Sham transactions are typically wholly circular or involve no genuine economic risk.
- Relationship to codified economic substance. The sham transaction doctrine overlaps with but is broader than § 7701(o).
- A transaction may fail the sham transaction test even if it technically satisfies both prongs of § 7701(o).
- Related party circular cash flows are particularly vulnerable to sham transaction challenges.
- If a transaction is found to be a sham → all claimed tax benefits are denied.
- Gregory v. Helvering foundational requirement. A transaction must serve a genuine business purpose beyond tax reduction to receive favorable tax treatment.
- The doctrine traces to Gregory v. Helvering, 293 U.S. 465 (1935) in which the Supreme Court denied nonrecognition treatment to a transaction that complied literally with the reorganization statute but served no business purpose.
- A related party transaction that has no legitimate business rationale is at risk of recharacterization.
- The business purpose requirement is separate from and additive to § 267's mechanical rules.
- CAUTION. Judicial doctrines operate independently of and in addition to § 267. Even if a transaction technically avoids § 267 through structuring that eliminates the § 267(b) relationship → the IRS may still challenge under step-transaction, substance-over-form, or economic substance.
- A loss sale structured through an unrelated intermediary may be collapsed and the loss disallowed under the step-transaction doctrine.
- A circular cash flow designed to create a deductible payment may be disregarded as a sham transaction.
- These doctrines apply even when the related party relationship is eliminated through constructive ownership exceptions or attribution waivers.
"Any person required to file a return under this section who fails to file such return on the date prescribed therefor shall pay a penalty of $25,000." (IRC § 6038A(d))
- Form 5472 for foreign-owned US corporations. A 25-percent foreign-owned US corporation or a foreign corporation engaged in a US trade or business must file Form 5472 to report related party transactions (IRC § 6038A).
- Part IV of Form 5472 requires reporting of amounts paid to foreign related persons including rents, royalties, commissions, interest, and other expenses.
- The form is filed with the corporation's income tax return (Form 1120 or 1120-F).
- The penalty for failure to file a timely Form 5472 is $25,000 per form per year (IRC § 6038A(d)).
- Form 5471 for controlled foreign corporations. Every US person who controls a foreign corporation must file Form 5471 (IRC § 6046).
- The form requires detailed information about the foreign corporation's income, balance sheet, and transactions with related parties.
- Controlled foreign corporation status may trigger Subpart F inclusions that interact with § 267 deduction deferrals.
- Failure to file Form 5471 carries a $10,000 penalty per form per year with additional penalties for continued failure (IRC § 6038(b)).
- Form 1042 and Form 1042-S for withholding on related party payments. Annual withholding tax returns are required for interest and other payments to related foreign persons.
- Form 1042 is the Annual Withholding Tax Return for US Source Income of Foreign Persons.
- Form 1042-S reports specific amounts of US source income subject to withholding paid to each foreign recipient.
- Related party interest payments to foreign persons generally require withholding at 30 percent unless a treaty or statutory exception reduces the rate.
- Schedule M-3 on Form 1120 for book-tax reconciliation. Schedule M-3 requires corporations to reconcile book income to taxable income and disclose related party transactions.
- Part II of Schedule M-3 requires disclosure of book-tax differences for related party expenses.
- Failure to properly report related party book-tax differences may trigger examination of § 267 and § 482 issues.
- The schedule applies to corporations with total assets of $10 million or more.
- ASC 740 (FIN 48) disclosure of uncertain tax positions. Public companies and certain other entities must disclose uncertain tax positions under ASC 740-10 (formerly FIN 48).
- A § 267 related party transaction that lacks clear authority must be evaluated for recognition and measurement under ASC 740.
- The unit of account for FIN 48 purposes may group related party transactions that are subject to § 267.
- Disclosure includes the nature of the uncertainty, the potential financial statement impact, and the reasonably possible change in the next 12 months.
- § 482 contemporaneous transfer pricing documentation. Taxpayers engaged in related party transactions subject to § 482 must maintain contemporaneous documentation.
- The documentation must be provided to the IRS within 30 days of request (Treas. Reg. § 1.6662-6(d)(2)(iii)).
- Failure to maintain adequate documentation may trigger the § 6662(e) net adjustment penalty of 20 percent of the tax underpayment attributable to the transfer pricing adjustment.
- The documentation must include an overview of the business, an analysis of the controlled transactions, a functional analysis, and a description of the transfer pricing method selected.
- Form 8865 for certain foreign partnerships. A US person who acquires or holds a controlled interest in a foreign partnership must file Form 8865 (IRC § 6038).
- The form reports the partnership's income, deductions, and the US person's distributive share.
- Related party transactions between a US partner and a foreign partnership may require disclosure under Form 8865 and trigger § 267 analysis.
- Penalties for failure to file are assessed separately from other information return penalties.
- CAUTION. Information return penalties are steep and accumulate annually. Form 5472 penalties of $25,000 per form per year are non-negotiable and not subject to reasonable cause abatement in all circumstances.
- Every foreign-owned US corporation must file Form 5472 even if it has no reportable transactions in a given year.
- Multiple related corporations may each have separate filing obligations.
- Late filing or failure to file triggers automatic assessment of the penalty.
"Taxable income means taxable income as defined in Section 63 of the Internal Revenue Code." (Cal. Rev. & Tax. Code § 17071)
- General state conformity through federal taxable income starting point. States generally conform to § 267 through statutes that adopt federal taxable income or federal adjusted gross income as the state tax starting point.
- Most states incorporate federal taxable income by reference which carries § 267 disallowances and deferrals into the state tax base.
- Conformity may be rolling (automatically follows current federal law) or fixed date (conforms to federal law as of a specific date).
- If a state uses fixed-date conformity → verify whether the state's conformity date captures the relevant § 267 provision.
- California combined reporting modifications. California conforms to § 267 through Rev. & Tax. Code § 24427.
- California's water's-edge manual Chapter 11 contains detailed analysis of § 267 in the combined reporting context.
- Under California's water's-edge election the federal consolidated return regulations apply to the combined report but § 267(f) takes precedence where the two conflict.
- The § 267(f) loss deferral rules generally override the consolidated return intercompany transaction rules for California purposes.
- Non-conforming state modifications. Some states have modified related party rules or additional addbacks for related party expenses.
- States may require addback of related party interest, rent, or royalty expenses even when § 267 does not disallow the deduction at the federal level.
- Addback statutes often apply when the related party is not subject to tax in the same state or pays tax at a lower rate.
- The addback may be avoided through a showing that the transaction meets an arm's-length standard or satisfies a treaty-based exception.
- TRAP. State conformity is not automatic and decoupling is common. Practitioners must check the specific state's conformity method and any modifications to § 267 for every return filed.
- A transaction that is deferred under § 267(a)(2) at the federal level may receive different treatment for state tax purposes.
- Some states decouple from § 267(f) controlled group loss deferral and instead allow immediate loss deduction.
- State addback provisions may apply even to transactions that are fully respected under § 267.
"No deduction shall be allowed in respect of any loss from the sale or exchange of property, directly or indirectly, between persons specified in any of the paragraphs of subsection (b)." (IRC § 267(a)(1))
- Loss-harvesting sales to related parties. A taxpayer cannot sell property at a loss to a related party to harvest capital losses for current-year use.
- § 267(a)(1) disallows the loss in full. The related party's basis is the actual cost paid (not the transferor's basis and not adjusted for the disallowed loss).
- The only available benefit is § 267(d) gain offset if the related party later sells the property at a gain to an unrelated person.
- If the related party never sells at a gain or sells at a loss → the original disallowed loss is lost forever.
- Gift-based basis shifting strategy. Transferring property by gift to a related party does not trigger § 267(a)(1) because a gift is not a sale or exchange.
- § 267(d) does not apply to donees. A donee takes carryover basis under § 1015.
- The donee's holding period includes the donor's holding period under § 1223(2).
- The strategy has limited utility because the donee receives the donor's basis without any step-up or adjustment.
- S corporation 50-percent shareholder threshold. A shareholder who owns exactly 50 percent of an S corporation can deduct losses on sales to the corporation.
- § 267(b)(2) requires more than 50 percent stock ownership to trigger related party status. Exactly 50 percent does not satisfy the test.
- A shareholder owning 50.1 percent or any amount over 50 percent is subject to § 267(a)(1) loss disallowance.
- The threshold is strict. Measure ownership after applying all § 267(c) constructive ownership rules.
- Family limited partnership attribution traps. Attribution through partnerships can create unexpected related party status under § 267(c)(1).
- § 267(c)(1) attributes ownership from a partnership to its partners proportionately.
- A family limited partnership with related partners may cause constructive ownership that triggers § 267 across multiple family entities.
- Check both direct ownership and constructive ownership through all partnership layers before concluding that § 267 does not apply.
- Installment sales to related parties. The tax treatment of installment sales to related parties depends on the character of the transaction.
- Gain transactions subject to § 1239 (depreciable property between related parties) cannot use the installment method (§ 453(g)).
- Loss transactions may be structured as installment sales but the loss itself is disallowed under § 267(a)(1).
- Related party installment sales trigger § 453(e) second disposition rules requiring accelerated gain recognition if the related party resells within 2 years.
- Controlled group loss planning under § 267(f). § 267(f) defers rather than disallows losses on sales between members of a controlled group.
- A controlled group structure may preserve loss benefits better than a direct related party sale because the deferred loss is recognized when the property leaves the group.
- Compare the § 267(f) deferral outcome with the § 267(a)(1) permanent disallowance outcome when choosing a transactional structure.
- If the property will remain within the controlled group indefinitely → the § 267(f) deferral becomes functionally equivalent to a disallowance.
- Circular cash flow arrangements. The IRS scrutinizes circular cash flows between related parties for lack of bona fide payment.
- Battelstein v. Commissioner, 611 F.2d 1033 (5th Cir. 1980) (circular cash flow between related parties is not a bona fide payment for § 267(a)(2) purposes).
- CCA 201334037 (IRS examines whether circular cash flows between related parties constitute bona fide payments for deduction matching under § 267(a)(2)).
- A payment that returns to the payor through a prearranged circular route may be disregarded as lacking economic substance.
- EXAMPLE. Individual A's loss sale to controlled corporation. Individual A owns 55 percent of Corporation X. A sells land with a basis of $500,000 and fair market value of $400,000 to Corporation X.
- The $100,000 realized loss is disallowed under § 267(a)(1). Corporation X takes a basis of $400,000.
- If Corporation X later sells the land to an unrelated buyer for $550,000 → realized gain is $150,000 and recognized gain is $50,000 after applying the $100,000 disallowed loss under § 267(d).
- If Corporation X later sells the land for $350,000 → realized loss is $50,000 and the $100,000 disallowed loss is lost forever because § 267(d) only reduces gain not loss.
- Documentation requirements for every engagement. Every related party transaction analysis must be documented in the engagement file.
- Create a schedule showing each party's direct ownership percentage and source.
- Compute constructive ownership through attribution under § 267(c) for every relevant entity type.
- Identify the specific § 267(b) relationship category that applies or confirm that no category applies.
- Classify the transaction type (loss sale, gain sale, expense payment, interest payment, etc.).
- State whether the loss is disallowed, deferred, or allowed and provide the statutory authority.
- Compute basis for the transferee and track any § 267(d) gain offset potential.
- Retain the documentation for the statute of limitations period plus any applicable extension.