Any time you are considering selling property at a loss, you need to take into account the rules governing the deduction of losses in transactions between certain related parties.
At one time, taxpayers attempted to set up phantom sales with related taxpayers with the sole purpose of creating tax losses. To avoid the difficulties presented in trying to distinguish phantom sales from bona fide sales between related taxpayers, Congress simply imposed an absolute prohibition against deductions in such transactions – regardless of whether the sale was bona fide, voluntary or involuntary, or direct or indirect. Thus, a loss on the sale or exchange of property between related persons is not deductible. For purposes of this rule, related persons include:
(1) members of a family, including only brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.);
(2) an individual and a corporation in which the individual owns more than 50 percent of the value of the outstanding stock;
(3) two corporations that are members of the same controlled group;
(4) a grantor and fiduciary of the same trust;
(5) fiduciaries of two different trusts for which the same person is the grantor;
(6) a fiduciary and beneficiary of the same trust;
(7) a fiduciary and beneficiary of two different trusts for which the same person is the grantor;
(8) a fiduciary of a trust and a corporation in which the trust or the grantor of the trust owns more than 50 percent of the value of the outstanding stock;
(9) a person and a Section 501 tax-exempt organization that is directly or indirectly controlled by that person or, if the person is an individual, family members of that person;
(10) a corporation and a partnership in which the same persons own more than 50 percent of the outstanding stock of the corporation and more than 50 percent of the capital or profits interest of the partnership;
(11) two S corporations in which the same persons own more that 50 percent of the value in the outstanding stock of each corporation;
(12) an S corporation and a C corporation in which the same persons own more that 50 percent of the value in the outstanding stock of each corporation; and
(13) an executor and beneficiary of an estate, unless the sale or exchange is in satisfaction of a bequest for a sum of money.
This disallowance rule applies to both direct and indirect transactions. Thus, for example, you cannot deduct your loss on the sale of stock through your broker if, under a prearranged plan, a related person or entity buys the same stock you had owned. This does not apply to a cross-trade between related parties through an exchange that is purely coincidental and is not prearranged. Further, if a sale or exchange is between any of these related persons and involves the lump-sum sale of a number of blocks of stock or pieces of property, you must calculate the gain or loss separately for each block of stock or piece of property. The gain on each item is taxable. The loss on any item is nondeductible. Gains from the sales of any of these items cannot be offset by losses on the sales of any of the other items.
When a loss is not deductible under these rules and the recipient of the property subsequently sells or exchanges the property at a gain, that gain is recognized only to the extent it exceeds the amount of the nondeductible loss.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357