The Ultimate Guide to IRC Section 267: Related Party Transactions

LEGAL DISCLAIMER: This article provides general, informational content for educational purposes only. It is not a substitute for professional legal advice from a qualified attorney or certified public accountant (CPA). Tax laws are complex and subject to change. Always consult with a qualified professional for guidance on your specific financial situation.

Imagine you and your brother are playing Monopoly. You own a property, Baltic Avenue, that's not doing well. You're low on cash. To get money from the bank, you “sell” Baltic Avenue to your brother for a huge loss, and he gives you cash he just got from passing Go. In the game's context, you've essentially just moved money between yourselves to manipulate the bank. The internal_revenue_service_irs views certain transactions between family members and controlled businesses in a similar light. They see the potential for a family or a single controlling interest to shuffle assets around not for a real business reason, but to create an artificial tax loss or manipulate the timing of deductions. irc_section_267 is the internal_revenue_code's rulebook designed to stop these “Monopoly games” in real life. It's a powerful anti-abuse rule that prevents taxpayers from claiming artificial losses or exploiting timing differences in deductions when dealing with people and businesses they are closely connected to. It operates on a simple premise: a transaction between related parties isn't the same as a true, open-market transaction between strangers, and the tax treatment shouldn't be the same either.

• Key Takeaways At-a-Glance:
  • Loss Disallowance Rule: IRC Section 267 permanently disallows any tax deduction for losses from the sale or exchange of property directly or indirectly between related parties. capital_loss.
  • Expense Matching Rule: IRC Section 267 prevents a business using accrual_basis_accounting from deducting an expense owed to a related person using cash_basis_accounting until the moment that person actually receives the payment and includes it in their income.
  • Broad Definition of “Related”: The rules for who is a related party under IRC Section 267 are incredibly broad, including not just immediate family but also entities you control, and even entities controlled by your family through complex “constructive ownership” rules. constructive_ownership.

The roots of Section 267 are planted in the soil of the Great Depression. During the economic turmoil of the 1920s and 1930s, the stock market was highly volatile. Sophisticated, high-income taxpayers devised a simple but effective strategy to avoid taxes. A wealthy individual holding stock that had plummeted in value would “sell” it to a closely related party—often a spouse, a child, or a wholly-owned corporation—at a massive loss. On paper, this generated a significant `capital_loss`, which they would then use to offset other investment gains, dramatically reducing their tax bill. In reality, however, nothing had changed. The stock was still “in the family,” and the economic position of the family unit was identical. The original owner could often buy the stock back after a short period, having successfully “harvested” a tax loss without any real economic risk. Congress recognized this as a major loophole that undermined the fairness of the tax system. In the Revenue Act of 1934, and later codified in the Internal Revenue Code of 1939, lawmakers introduced the predecessor to Section 267. The intent was clear and uncompromising: to create an absolute, mechanical rule that would put an end to these artificial loss-generating schemes. The law wasn't designed to question the taxpayer's motives or determine if a specific sale was a sham; it was designed to create a bright-line rule that said, “If you sell at a loss to a related party, the loss is disallowed. Period.” This proactive, rather than reactive, approach has defined the section ever since.

irc_section_267 of the `internal_revenue_code` is the primary federal statute governing these transactions. It's broken down into two main prohibitions that every small business owner, investor, and family-run enterprise must understand. The Loss Disallowance Rule - Section 267(a)(1): The statutory language states: *“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).”*

• Plain English Translation: You absolutely cannot claim a tax deduction for a loss you incur when selling or trading property to a person or entity the law considers “related” to you. It doesn't matter if you sold the property for its fair market value or if the sale was made for legitimate business reasons. The rule is automatic and unforgiving. If the buyer is on the “related party” list, your loss is disallowed for tax purposes.

The Expense Matching Rule - Section 267(a)(2): The statute is more complex here, but its core principle is about timing. It essentially states that if an accrual-method taxpayer owes a business expense or interest to a related cash-method taxpayer, the accrual-method taxpayer cannot take the deduction until the day the amount is includible in the gross income of the cash-method recipient.

• Plain English Translation: Imagine your corporation (which uses accrual accounting) owes you, its cash-basis owner, a $20,000 bonus for Year 1. The company declares the bonus in December of Year 1 but doesn't actually pay you the cash until February of Year 2. Without Section 267, the company could deduct the $20,000 expense in Year 1, while you wouldn't report the income until Year 2. Section 267(a)(2) stops this. It forces the company to “match” its deduction to your income. The company cannot deduct the $20,000 bonus until Year 2, the same year you actually receive it and report it on your personal tax return.

While IRC Section 267 is a federal law, its practical application can feel different depending on your business structure. The core rules are the same, but who is considered “related” and how the rules are triggered can vary.

To truly understand Section 267, you must break it down into its four key components: the two main rules (Loss Disallowance and Matching) and the two crucial definitions (Related Party and Constructive Ownership).

This is the most famous and direct application of the law. It creates a simple, bright-line test.

• How it Works: Suppose you own 1,000 shares of XYZ Corp., which you bought for $50,000. The stock has since declined in value to $30,000. You want to realize this $20,000 loss to offset other capital gains. You decide to sell all 1,000 shares to your sister for the current fair market value of $30,000.
• The Result: Under Section 267(a)(1), your $20,000 loss is disallowed. You cannot deduct it on your `irs_form_1040_schedule_d`. The IRS views this transaction as if the stock never left the family's economic control.

Is the Disallowed Loss Gone Forever? Not Quite. Section 267(d) provides a special relief rule for the *subsequent* sale of the property. The disallowed loss can be used by the related person who originally bought the property to reduce the gain on a *later* sale to an unrelated third party.

• Example Continued: Your sister holds the XYZ shares for two years, during which the stock recovers. She then sells the shares to an unrelated investor on the open market for $60,000.
  • Her actual gain is $30,000 ($60,000 sale price - $30,000 purchase price).
  • However, she can now use your previously disallowed loss of $20,000 to offset her gain.
  • Her taxable gain is reduced to just $10,000 ($30,000 gain - $20,000 disallowed loss).

Important Caveat: This relief rule only applies to gains. If your sister had sold the stock for $25,000 (a $5,000 loss), she could not add your original $20,000 disallowed loss to her own loss. The original disallowed loss would simply vanish forever.

This rule is more nuanced and attacks a different kind of tax mischief: timing. It ensures that the payer and the recipient of money between related parties report the transaction in the same tax year.

• The Mismatch Problem: Businesses often use `accrual_basis_accounting`, where they record expenses when they are incurred, not when they are paid. Individuals typically use `cash_basis_accounting`, where they report income only when they receive the cash. This creates a potential mismatch.
• How Section 267 Fixes It: Let's say you are the 100% owner of a successful S-Corporation. Your company is an accrual-basis taxpayer, and you are a cash-basis taxpayer. On December 15, 2023, your company's board (which is just you) votes to give you a $50,000 performance bonus for your work in 2023. The company's books “accrue” this as a $50,000 expense in 2023. However, the company doesn't actually cut you the check until January 30, 2024.
• The Result: Because you and your wholly-owned corporation are related parties, Section 267(a)(2) kicks in. The corporation cannot deduct the $50,000 bonus expense on its 2023 tax return. It must wait and take the deduction on its 2024 tax return, because 2024 is the year you actually received the cash and will report it as income. The deduction and the income are “matched” in the same tax year.

This is the heart of the law. If the parties to a transaction are not on this list, Section 267 does not apply. The definition is extremely specific and wide-ranging.

• Key Related Parties Include:
  • Family Members: This is narrowly defined. It includes only your:
    • Spouse
    • Siblings (whole or half-blood)
    • Ancestors (parents, grandparents)
    • Lineal descendants (children, grandchildren)
    • Important Note: In-laws, aunts, uncles, cousins, nephews, and nieces are NOT considered related parties under this specific family definition.
  • An Individual and a Corporation: If an individual owns more than 50% (in value) of the outstanding stock of a corporation, they are related parties.
  • Two Corporations in a Controlled Group: This applies to parent-subsidiary or brother-sister corporations that share common ownership.
  • A Grantor and a Fiduciary of a Trust: The creator of a trust and the person/entity managing it are related.
  • A Fiduciary and a Beneficiary of a Trust: The manager and the recipient of a trust's assets are related.
  • A Corporation and a Partnership: If the same people own more than 50% of the corporation's stock and more than 50% of the partnership's capital or profits interest.
  • An S Corporation and Another S Corporation (or a C Corporation): If the same people own more than 50% of the stock in both corporations.

This is where Section 267 gets its true power and complexity. To determine if you own “more than 50%” of a company, the IRS doesn't just look at the shares you personally own. It also attributes ownership to you from other people and entities. This is called `constructive_ownership`. Think of it as the IRS assuming that you have influence or control over shares owned by your closest relatives or business partners.

• The Core Attribution Rules:
  • Family Attribution: Stock owned by a family member (as defined above) is treated as being owned by you.
    • Example: You personally own 30% of a corporation. Your father owns 25%. For the purposes of the 50% test, the IRS considers you to own 55% (your 30% + your father's 25%). You and the corporation are now related parties.
  • Entity-to-Owner Attribution: Stock owned by a corporation, partnership, estate, or trust is treated as being owned proportionally by its shareholders, partners, or beneficiaries.
    • Example: You own 50% of a partnership. That partnership owns 40% of a separate corporation's stock. The IRS attributes half of the partnership's holding to you, so you are treated as owning 20% of the corporation's stock through the partnership.
  • Partner-to-Partner Attribution: Stock owned by your partner in a partnership is attributed to you (if you also own stock in the same corporation). This rule is particularly tricky and can create unexpected related parties.

These rules can chain together in complex ways, making it essential to map out ownership structures carefully before any transaction.

If you are planning a transaction that might involve a related party, a proactive, systematic approach is crucial.

1. First, determine the nature of the transaction.
2. Is it a sale or exchange of property? This could be real estate, stocks, bonds, business vehicles, or equipment. If so, you need to be on high alert for the Loss Disallowance Rule (267(a)(1)).
3. Is it the payment of an expense or interest? This could be salary, bonus, rent, or a loan between related parties. If so, the Matching Rule (267(a)(2)) is your primary concern.

1. This is the most critical step. You must determine if the two parties to the transaction are “related” under Section 267(b).
2. Direct Relationships: Start by checking the basic list. Is it a transaction between you and your spouse, child, or parent? Is it between you and a corporation where you personally own more than 50% of the stock?
3. Constructive Ownership Analysis: If the direct relationship isn't obvious, you must perform a `constructive_ownership` analysis.
   • Create a diagram of all individuals and entities involved.
   • List the direct ownership percentages for everyone.
   • Apply the attribution rules. Add stock owned by family members to each other's totals. Attribute stock owned by partnerships or S-corps to the owners.
   • Calculate the final, constructive ownership percentage for each person. If anyone crosses the 50% threshold, the parties are related.

1. If it's a loss sale: Understand that any loss will be disallowed for the seller. However, remember the relief rule for the buyer. Document the disallowed loss meticulously, as the buyer will need this information to potentially reduce their gain on a future sale. Consider whether it's better to sell the asset to an unrelated party to recognize the loss.
2. If it's an expense payment: For accrual-basis businesses paying cash-basis owners, the solution is simple: ensure the payment is made within the same tax year the expense is accrued. For calendar-year businesses, this means making salary, bonus, and interest payments before December 31st.

1. Even though Section 267's rules are mechanical, documentation is key, especially if you are ever audited by the `internal_revenue_service_irs`.
2. For property sales, keep records of the `fair_market_value` appraisal, the purchase agreement, the calculation of the disallowed loss, and communication to the buyer about the potential future tax benefit.
3. For expense payments, keep board meeting minutes authorizing bonuses, payroll records showing the date of payment, and bank statements confirming the transfer of funds.

1. Section 267 is not a do-it-yourself area of tax law. The constructive ownership rules are notoriously complex. Before selling property or structuring payments between family members or controlled businesses, always consult a qualified CPA or tax attorney. They can help you map ownership, identify potential pitfalls, and explore alternative transaction structures that achieve your economic goals without triggering these punitive rules.

There is no specific “Form 267” to file. Instead, the rules of Section 267 affect how you report information on other standard tax forms.

• irs_form_1040_schedule_d, Capital Gains and Losses: This is where a disallowed loss would become an issue. If you sell stock to a related party at a loss, you cannot report that loss here. You must maintain separate records of the disallowed loss for the buyer's potential future use.
• irs_form_1120 (U.S. Corporation Income Tax Return) or irs_form_1120-s (U.S. Income Tax Return for an S Corporation): This is where the expense matching rule has its impact. If your corporation accrues a bonus to you in December but pays it in January, it cannot claim the deduction for that expense on this form for the first year. The expense deduction must be moved to the following year's return.
• Transaction and Ownership Documents: More important than any single tax form are the underlying legal and financial documents. This includes stock ledgers, partnership agreements, trust documents, and purchase agreements. These documents are the source of truth for determining ownership and relationship status under Section 267.

Court cases involving Section 267 often reinforce its mechanical and unforgiving nature. The courts have consistently sided with the IRS's interpretation that the taxpayer's intent is irrelevant.

• The Backstory: A husband who managed his and his wife's investment portfolios sold certain stocks from his own account at a loss. On the very same day, he purchased the exact same number of shares of the same stocks for his wife's account using her separate funds.
• The Legal Question: The husband argued that since he was just an agent for his wife and used her separate money, it wasn't a “direct or indirect” sale between them. He claimed he sold his shares on the open market and she bought different shares on the open market.
• The Court's Holding: The `supreme_court_of_the_united_states` disagreed. They ruled that this was a classic “indirect” sale between related parties (a husband and wife). The Court held that the purpose of Section 267 was to put an end to all such loss-harvesting schemes within an “intimate family group.” It established that the rule is absolute and doesn't depend on the good faith or intentions of the taxpayer.
• Impact Today: *McWilliams* cemented the “no excuses” interpretation of Section 267. It tells every taxpayer that you cannot easily get around the rule by adding intermediate steps or using the public stock market as a wash. If the net result is that an economic loss is realized for tax purposes but the asset remains within the family unit, the loss will be disallowed.

• The Backstory: This complex case involved a family feud and a stock redemption. A family corporation bought back (redeemed) all the stock held by a trust that benefited some family members. The trust claimed a loss on the redemption. The core of the dispute was about family hostility and whether it should override the mechanical attribution rules.
• The Legal Question: The trust argued that because the family members were feuding and acting as adversaries, the “family attribution” rules of constructive ownership shouldn't apply. They claimed the transaction was a true, arm's-length deal driven by animosity, not collaboration.
• The Court's Holding: The Fifth Circuit Court of Appeals ruled against the taxpayer. It held that there is no “family hostility” exception to the constructive ownership rules of Section 267©. The court stated that the statute provides a set of objective, mechanical tests, and trying to inject a subjective test based on family harmony (or lack thereof) would make the law unworkable.
• Impact Today: *Metzger Trust* is a stark reminder of the rigidity of the constructive ownership rules. It confirms that you cannot argue your way out of the rules based on personal circumstances or intent. The family tree and the ownership chart are all that matter.

While Section 267 is a long-established law, its application in the modern economy continues to spark debate. The primary controversy revolves around its mechanical nature. Critics argue that the rule can sometimes be a blunt instrument, penalizing legitimate, `arm_s_length_transaction`s that just happen to occur between parties who are technically “related.” For instance, a sale of property at a genuine loss between siblings who have no business or financial connection other than their family tie can be disallowed, which some see as unfair. Another area of complexity is the interaction of Section 267 with the ever-more-complex structures of pass-through entities like LLCs and partnerships. As businesses use multi-layered ownership structures involving various trusts and holding companies, tracing constructive ownership becomes an incredibly difficult task, potentially leading to inadvertent violations of the rule.

The digital economy and decentralized finance (DeFi) may pose the next great challenge to Section 267. How does the rule apply to the sale of a crypto asset at a loss between the digital wallets of two related parties? The principles remain the same, but the practicalities of tracing anonymous or pseudonymous transactions present a new enforcement hurdle for the IRS. Furthermore, evolving family structures and business relationships could test the boundaries of the “related party” definition. As more small businesses operate globally with family members spread across countries, the interplay of Section 267 with international tax treaties and foreign ownership structures will become increasingly relevant. While Congress is unlikely to fundamentally change the core principles of Section 267, we may see future legislation or IRS regulations aimed at clarifying its application to these new technologies and business models.

• accrual_basis_accounting: An accounting method where revenue and expenses are recorded when they are earned or incurred, regardless of when cash is exchanged.
• arm_s_length_transaction: A transaction between two independent, unrelated, and well-informed parties, where neither is under any duress to transact.
• attribution_rules: Tax code rules that treat a taxpayer as owning stock that is actually owned by a related person or entity; also known as constructive ownership.
• capital_gain: The profit realized from the sale of a capital asset, such as stock or real estate.
• capital_loss: The loss incurred from the sale of a capital asset for less than its purchase price.
• cash_basis_accounting: An accounting method where revenue and expenses are recorded only when cash is actually received or paid out.
• constructive_ownership: The legal fiction in tax law where an individual is treated as owning stock held by family members or related entities.
• controlled_group: A group of two or more corporations connected through common ownership.
• fair_market_value: The price that a property would sell for on the open market between a willing buyer and a willing seller.
• internal_revenue_code: The main body of domestic statutory tax law for the United States.
• internal_revenue_service_irs: The U.S. government agency responsible for tax collection and enforcement of tax laws.
• related_party: A person or entity that has a special relationship with another, as specifically defined in IRC Section 267(b).
• statute: A written law passed by a legislative body.

• internal_revenue_code
• capital_gains_and_losses
• constructive_ownership
• accrual_basis_accounting
• cash_basis_accounting
• tax_audits
• corporate_tax