Related Party Business Transactions

Related-party tax rules do not use one universal definition for every provision. Family relationships, direct ownership and constructive ownership can establish a relationship for a particular loss or timing rule. Determine which provision applies, then apply its relationship and attribution tests. A statement that two people are friends or business associates is not enough; a nominal ownership percentage may also be incomplete when attribution applies.

For common family loss-disallowance rules, spouses, siblings, ancestors and lineal descendants can be included, while cousins are not included merely because they are relatives in ordinary speech. Entity relationships can depend on more-than-50% ownership and other specified connections. Identify the relevant testing date. The expense-matching rule can test the relationship at year end rather than simply on the eventual payment date.

When an applicable related-party rule disallows a loss, the seller cannot deduct that loss in the ordinary way. The buyer generally still has cost basis, rather than automatically inheriting the seller’s higher basis. On a later sale by the related buyer, a special recognition rule can reduce the buyer’s gain by the previously disallowed loss to the extent permitted. That is a gain-recognition adjustment, not an unrestricted transfer of the seller’s loss deduction.

If the later gain is smaller than the disallowed loss, the rule can eliminate the gain without creating a new deductible loss for the unused excess. If the buyer later sells below their own cost, the seller’s disallowed loss does not simply enlarge the buyer’s loss. Distinguish realized gain, recognized gain and basis before selecting an answer. Different related-party transfers or property uses can also change gain character.

An accrual-method business may otherwise satisfy its deduction requirements before payment, but a related cash-method recipient generally does not include the receipt until paid. The applicable related-party rule can defer the business’s deduction until payment and corresponding inclusion by the recipient. Accruing an interest or compensation payable at year end therefore does not always create a current deduction.

Keep the reason for the adjustment explicit. A related-party loss disallowance and a related-party payment-timing deferral are different mechanisms. One concerns recognition of a loss on a transfer; the other coordinates years of deduction and inclusion. A ledger with transaction date, relationship, both accounting methods, payment date and tax treatment prevents an answer that correctly identifies related parties but applies the wrong consequence.