Related-Party Loss Disallowance (§ 267)

IRC § 267 permanently disallows losses on sales and exchanges of property between related parties — erasing the deduction entirely rather than suspending it — as a guard against taxpayers who generate artificial tax losses by selling depreciated assets to family members or controlled entities while retaining the asset's effective economic benefit within the family or business. The rule is strict: if you sell stock worth $40,000 to your daughter for $40,000 (a fair price) but your basis is $90,000, the $50,000 loss is disallowed — not deferred — even though the sale was arm's-length in price. The disallowed loss does not disappear entirely from the tax system: it travels with the buyer as a potential offset against gain, but only against gain — if the buyer later sells to an unrelated party at a gain of $30,000, the gain is reduced to zero by $30,000 of the suspended loss; if the buyer sells at an $80,000 gain, she pays tax on $30,000 (the gain above the seller's loss that was suspended). The other major arm of § 267 — the deduction timing rule — prevents accrual-basis related entities from front-loading deductions by accruing expenses owed to cash-basis related parties who haven't yet received payment: the accruing party cannot deduct until the related cash-basis party includes the amount in income. Together, these two rules address the most common ways family members and controlled entities have historically shifted losses and accelerate deductions across related tax returns.

Current Law (2026)

Key Mechanics

Section 267 disallows losses on sales or exchanges between related persons — the loss is permanently gone, not suspended. When a parent sells stock with a $90K basis to a child for $40K FMV, the parent's $50K loss is disallowed under § 267(a)(1). The child's basis is $40K (cost paid), not $90K. The disallowed loss does not add to the child's basis but floats as a suspended offset under § 267(d): if the child later sells to an unrelated party, the suspended amount reduces (but cannot eliminate) the child's recognized gain. Unused suspended loss above the gain is permanently lost — it never becomes a deduction. The deduction timing rule (§ 267(a)(2)) is independent: an accrual-basis company cannot deduct amounts owed to a related cash-basis person until actually paid, preventing mismatch between the corporation's deduction and the individual's income recognition. Related persons under § 267(b) include: siblings, spouse, ancestors, lineal descendants (not aunts/uncles/cousins/in-laws); corporation and >50% shareholder; partnership and >50% capital interest holder; trust and beneficiary; executor and beneficiary. Constructive ownership (§ 267(c)) applies family and entity attribution — stock owned by children or spouse is attributed to the parent for the 50% threshold test. The 50% threshold is lower than the 80% threshold used in consolidated return rules (§ 1502), so § 267 catches transactions that corporate affiliation rules miss. Contrast with wash sale rules (§ 1091): wash sale losses are suspended and added to the taxpayer's basis (recoverable on future sale); § 267 losses are permanently disallowed and give the buyer no basis step-up — § 267 is the harsher rule.

Legal Authority

• 26 U.S.C. § 267(a)(1) — Loss disallowance: no deduction allowed for losses on sales or exchanges of property between related persons
• 26 U.S.C. § 267(a)(2) — Deduction timing: accrual-basis taxpayer may not deduct amount owed to related cash-basis party until the amount is includible in the related party's income (i.e., until actually paid for a cash-basis recipient)
• 26 U.S.C. § 267(b) — Related persons defined: comprehensive list including family members, corporation/50%-shareholder, partnership/50%-partner, executor/beneficiary, related trusts
• 26 U.S.C. § 267(c) — Constructive ownership: family and entity attribution rules; stock owned by a family member or entity is attributed to the related person
• 26 U.S.C. § 267(d) — Amount of gain to be included — the offset rule: buyer may offset gain on subsequent sale by the amount of the disallowed loss, but cannot convert a gain into a loss; if gain is smaller than the disallowed loss, only the gain portion is offset, and the remainder of the disallowed loss is permanently lost
• 26 U.S.C. § 267 (DB) — Losses, expenses, and interest with respect to transactions between related taxpayers: prevents closely connected persons from taking a tax loss on sales or swaps between them; also prevents accrual-basis deductions for amounts owed to a related cash-basis person until that person reports it as income; special rules apply when the other person is a foreign company, including limits for CFCs and PFICs and an exception for ordinary business payments paid within 8½ months; for groups of related corporations, "more than 50 percent" (rather than 80 percent) controls whether the loss is postponed

How It Works

The loss disallowance rule prevents the classic "paper loss" transaction: selling an asset to a related party to generate a tax loss while keeping the asset within the family or related-party group. If a parent has stock worth $40,000 with a $90,000 basis (a $50,000 unrealized loss), selling to a child at $40,000 would generate a $50,000 loss — but § 267 disallows it. The parent has no deduction. The child takes a basis of $40,000 (what she paid), not $90,000 (the parent's original basis). The $50,000 disallowed loss travels with the child as a potential offset against her future gain when she sells the stock to an unrelated party.

The offset mechanism in § 267(d) is frequently misunderstood. The disallowed loss does not add to the buyer's basis — it is a separate, floating offset that can only reduce (not eliminate or reverse) the buyer's gain. Example: Parent sells stock with $90,000 basis to child for $40,000 FMV. Parent's $50,000 loss is disallowed. Child's basis is $40,000. If the child later sells to an unrelated party for $60,000, she has a $20,000 gain — but the $50,000 suspended offset reduces it to zero. The remaining $30,000 of suspended loss is permanently lost — it disappears without generating any deduction. If the child sells for $120,000, she has an $80,000 gain — the $50,000 suspended offset reduces it to $30,000 of recognized gain. The offset only applies to the extent of the buyer's actual gain; it cannot convert a gain into a loss, and unused suspended loss above the gain is gone.

Related persons for § 267 purposes include a broad but specific list. Family members are siblings (brothers and sisters — including half-siblings), spouse, ancestors (parents, grandparents, great-grandparents), and lineal descendants (children, grandchildren). Note: aunts, uncles, cousins, and in-laws are NOT included. For corporations, a shareholder who owns more than 50% by value (directly or constructively) is related. For partnerships, a partner who owns more than 50% of the capital interest is related. The constructive ownership rules of § 267(c) incorporate family and entity attribution: stock owned by a spouse or children is attributed to the parent when testing whether the parent owns >50% of a corporation, for example. This means you can be "related" to a corporation for § 267 purposes even without personally owning majority shares, if your family members' shares push the total over 50%.

The deduction timing rule (§ 267(a)(2)) operates independently of the loss disallowance rule. If Company A (accrual basis) accrues a deduction for $100,000 owed to its majority shareholder (cash basis individual) at year-end but doesn't actually pay until March of the next year, Company A cannot deduct the $100,000 in the current year under § 267 — even though accrual-basis accounting would normally recognize the expense. The deduction is delayed until the payment is actually made and included in the shareholder's income. This prevents the mismatch that would otherwise allow the corporation to front-load a deduction while the individual defers the income.

Wash sale rule comparison: The wash sale rules (§ 1091) disallow losses when a taxpayer sells securities and repurchases substantially identical securities within 30 days. Unlike § 267, wash sale losses are suspended and added to basis — they are not permanently lost. Section 267 is more severe: the loss is permanently disallowed, and the buyer gets no upward basis adjustment for the disallowed loss. The two rules address different fact patterns (wash sales are the same taxpayer cycling in and out; § 267 is different taxpayers in a related party network), but both serve the same anti-abuse purpose.

How It Affects You

If you're planning to sell a depreciated asset to a family member: The loss is disallowed. This is true even if the sale is at arm's-length fair market value — § 267 does not require a discounted price to trigger disallowance. If you have a genuine need to shift an asset to a family member (estate planning, business succession), consider whether you can donate the asset (allowing a charitable deduction if donated to charity), gift it (no loss deduction but the carryover basis could be useful to the recipient), or hold it until you can sell to an unrelated third party to capture the loss.

If you own a closely held business and transact with it: If you own more than 50% of a corporation by value (directly or through attribution from family members), you are related to the corporation under § 267. Sales of property between you and your corporation at a loss are disallowed. This is a common trap in family business planning — a shareholder selling a piece of equipment or real estate to the family corporation at a loss may discover the loss is disallowed if constructive ownership pushes the ownership percentage above 50%. Run the constructive ownership analysis (including attribution from your spouse and children) before any sale.

If you're the buyer of related-party property that was sold at a loss: Keep records of the disallowed loss amount — it is your potential offset against future gain when you eventually sell to an unrelated party. Your basis in the property is what you paid (FMV), not the seller's higher basis. Document the suspended loss carefully; it is a valuable tax asset that can reduce your tax on a future sale. Note that the offset only applies against gain to the extent of that gain — you cannot carry the unused portion forward or backward, and it cannot create a loss.

If your company accrues expenses owed to a related party (S corp owner, majority shareholder): Review whether the deduction timing rules of § 267(a)(2) apply. If you're an accrual-basis company that accrues year-end bonuses, management fees, or interest owed to a cash-basis majority owner, you cannot deduct until the amount is actually paid. The most practical approach: pay any amounts owed to related cash-basis parties before year-end. If operational constraints make year-end payment impractical, be aware the deduction will follow the payment into next year.

State Variations

Most states with income taxes follow the federal § 267 related-party loss disallowance rules for state income tax purposes. There is no separate state version of the rule; state conformity to the federal disallowance is generally automatic. California, New York, and other high-tax states conform. The practical effect is that a loss disallowed at the federal level under § 267 is also disallowed for state income tax purposes in most states.

Implementing Regulations

• 26 CFR 1.267(a)-1 — Disallowance of deductions for losses, expenses, and interest with respect to transactions between related taxpayers
• 26 CFR 1.267(b)-1 — Related taxpayers defined; family relationship rules; corporate and partnership relationships
• 26 CFR 1.267(c)-1 — Constructive ownership of stock; attribution rules
• 26 CFR 1.267(d)-1 — Amount of gain to be included when related-party buyer later sells; the offset mechanism

Pending Legislation

No significant § 267 reform legislation is pending as of 2026. The related-party loss rules have been broadly stable for decades. Proposals to tighten family attribution rules (covering cousins, in-laws, and other relationships not currently in § 267) have appeared in academic tax reform proposals but have not advanced in Congress.

Recent Developments

• Digital assets and related-party losses: The IRS has confirmed that cryptocurrency and other digital assets are "property" for § 267 purposes. Taxpayers who transfer cryptocurrency at a loss to family members or controlled entities cannot deduct the loss. The wash sale rules (§ 1091) do not currently apply to cryptocurrency (only to securities), but § 267 does — creating an asymmetry where crypto-to-crypto "harvesting" transactions with unrelated parties are not subject to wash sale rules while related-party transfers remain subject to § 267.
• Family LLC and trust planning: Family limited partnerships (FLPs) and family LLCs are common estate planning vehicles. When these entities are treated as related parties under § 267 (because family members collectively own more than 50%), transactions between family members and the entity are subject to loss disallowance. Tax advisors structuring FLPs must map the constructive ownership network carefully.
• Section 267A — hybrid mismatches: A separate but similarly numbered provision, § 267A (enacted in TCJA), disallows deductions for "disqualified related party amounts" in cross-border hybrid mismatch arrangements — a different rule addressing international tax structuring. The two provisions are unrelated in substance; § 267 governs domestic related-party transactions while § 267A targets international hybrid arrangements.