No-Loss Tax Rules: Beware of Selling Property to a Relative at a Loss

Before you sell a property to a relative at a loss, stop and find out more about the tax consequences.

Special tax rules—like the loss disallowance rule—make it a bad idea.

In a nutshell, you won’t be able to claim the loss on such a sale and neither will the relative-buyer.

Tax Consequences of Selling Property to a Relative at a Loss

Congress was concerned about taxpayers taking tax losses on sales of their property while essentially retaining control and ownership of the property through a close family member.

According to tax law, a loss is disallowed on sale to related parties.

• No loss can be claimed on any sale of property to a relative.
• This rule applies even if there is no intent to avoid taxes and there is no control over the sold property (say, you are on bad terms with the relative-buyer). This fact doesn’t change the no-loss-permitted rule.
• A sale of loss property to an entity such as a corporation you control, a partnership in which you hold an interest, or certain trusts and estates, will also be subject to the loss disallowance rules.

Definitions for No-Loss Tax Rules

For purposes of these rules, “relative” means spouse, parent (or grandparent), child (or grandchild), and brother or sister (including half-brother or -sister).

The loss disallowance rules do not apply to sales to other relatives; i.e., cousins, nieces and nephews, aunts and uncles, or in-laws.

No-Loss Tax Rules: The Property Loss Is “Lost” Forever

The loss is not retained in the property and cannot be claimed by the relative if he or she sells it later.

The only benefit the relative may enjoy is that any gain on a later sale will be reduced by the previously disallowed loss.

Selling Property to a Relative: Example 1

Jack sells an asset to his sister Jill for $10,000. Jack’s basis in the asset was $15,000. Jill sells it for $10,000 to an unrelated third party.

• Jack cannot claim his $5,000 loss because the buyer was his sister.
• Despite this, Jill’s basis is just $10,000: her cost.
• When she sells the asset for $10,000, she doesn’t get the tax benefit of the loss either.

Selling Property to a Relative: Example 2

The facts are the same as in Example 1 except that Jill sells the asset for $17,000 (it appreciates in value after she buys it).

• In this case, even though Jill’s basis in the asset is her $10,000 cost, she only has to report $2,000 of her $7,000 gain. The $5,000 loss disallowed to Jack reduces Jill’s gain.
• Interestingly, while Jack is “penalized” with a loss disallowance, Jill benefits from his misfortune.

Selling Property to a Relative: Example 3

The facts are the same as in Example 1 except that Jill sells the asset for $7,000 (it goes down in value after she buys it).

• Jill can claim a $3,000 loss based on her $10,000 basis.
• While the $5,000 loss that accrued to Jack is “lost,” any drop in value that occurs after Jill buys the asset can be claimed by Jill when she sells it.

No-Loss Rules Apply to Indirect Sales Too

The disallowance rule also can’t be avoided by setting up a “straw” person as a non-relative.

For example, a person can’t sell the property to a non-relative who owns it briefly before reselling it to the original seller’s relative.

The no-loss rules apply to “indirect” sales as well.

In most cases, there’s a way to handle your assets in a more tax beneficial way. That’s why we help our clients with tax consulting and estate planning. If you are thinking about selling property to a relative or a business entity that you have an interest in, and would like to dive deeper into the tax consequences of such a sale, reach out to us at Smith Patrick CPA to discuss your specific situation.