How to File a Non-Arm’s Length Transaction Disclosure

To disclose a non-arm’s length transaction, you file the form that matches the type of deal: Form 5472 attached to Form 1120 for foreign-related corporate transactions, Form 709 for gifts or below-market sales between individuals, and a lender’s identity-of-interest disclosure for a real estate purchase financed with a mortgage. Each one asks for the same three things in different formats: who the related parties are, what the actual terms were, and evidence that the price reflects fair market value. The penalties for getting it wrong are heavy. A missing Form 5472 costs $25,000 per related party per year, and accuracy-related penalties run 20% to 40% of any tax underpayment caused by a misstated price.

Who Counts as a Related Party

Before you can disclose correctly, you need to know whether the IRS considers your counterparty “related.” Section 267 defines the term broadly. Family members include your spouse, parents, grandparents, children, grandchildren, and siblings (including half-siblings).¹

On the business side, an individual and a corporation are related if the individual owns more than 50% of the corporation’s stock by value. Two corporations under common control, a trust and its grantor or beneficiary, a partnership and a corporation with overlapping ownership above 50%, and two S corporations with the same majority owners all qualify.¹

The threshold is strict: 50.01% triggers the rules, exactly 50% does not. But constructive ownership can push you past the line. Stock held by your family members or by entities you own a stake in gets attributed to you. If you own 30% of a corporation and your spouse owns 25%, the IRS treats you as owning 55%.

Below-Market Loans Between Family or Shareholders

If you lend money to a family member or to a corporation you own and charge little or no interest, the IRS doesn’t ignore the missing interest. Section 7872 treats the gap between what you charged and the market rate as a taxable event.²

The benchmark is the Applicable Federal Rate (AFR), which the IRS publishes monthly in short-term, mid-term, and long-term tiers.³ Charge less than the AFR and the difference becomes “forgone interest.” For a gift loan between family members, the forgone interest is treated as transferred from the lender to the borrower as a gift, then retransferred back as interest income. The lender may owe gift tax on the spread and has to report the imputed interest.²

There is one useful escape: if the total outstanding balance between two individuals stays at $10,000 or less, Section 7872 doesn’t apply. That exception disappears if the borrower uses the money to buy income-producing assets like stocks or rental property.² The same $10,000 threshold covers corporation-shareholder loans, but it vanishes if tax avoidance is one of the principal purposes of the arrangement.

To disclose a below-market loan, document the principal, the stated rate (if any), the AFR for the month the loan was made, and the calculated forgone interest. The lender reports the imputed interest as income. If the forgone interest exceeds the annual gift tax exclusion, the lender also files Form 709.

Below-Market Sales and Gifts

Selling property to a relative at a discount creates a gift in the eyes of the IRS. If your home is worth $400,000 and you sell it to your daughter for $250,000, you’ve made a $150,000 gift that must be reported on Form 709.⁴

For 2026, the annual gift tax exclusion is $19,000 per recipient.⁵ Gifts below that amount don’t require a return, but a below-market property sale almost always exceeds it. Filing Form 709 doesn’t necessarily mean you owe tax. The lifetime exemption is $15,000,000 for 2026, and the gift is subtracted from that cap until it’s exhausted.⁶ Skipping the filing is where people get into real trouble: the IRS has no statute of limitations on a gift tax return that was never filed.

Form 709 is due on the same date as your individual income tax return (April 15, or your extended deadline). On the return, you describe the property, the sale price, the fair market value, and your relationship to the buyer. A qualified appraisal supporting the fair market value is the most important backup you can bring.

Foreign-Related Corporate Transactions: Form 5472

Section 482 gives the IRS broad power to reallocate income between related businesses if the prices they charge each other don’t reflect what unrelated companies would agree to. The rule applies to any two or more businesses under common ownership or control, domestic or foreign.⁷

The disclosure vehicle for cross-border related-party dealings is Form 5472. Any U.S. corporation that is at least 25% foreign-owned, and any foreign corporation doing business in the U.S., must file one for each related party it transacted with during the year. The form captures the dollar value of every category of related-party transaction: sales, purchases, rents, royalties, interest, and service fees.⁸ Form 5472 attaches to the corporation’s annual Form 1120 and shares the same deadline.

Single-member LLCs owned by a foreign person must file it too, even though they’re disregarded entities for other tax purposes. The IRS added this requirement specifically to catch foreign-owned LLCs that had been flying under the radar.

To prove your related-party prices are arm’s length, the regulations under Section 482 recognize several accepted methods, including the Comparable Uncontrolled Price method, the Resale Price method, and the Cost Plus method.⁹ Whichever you choose, the documentation supporting that choice needs to be in place before the filing deadline, not assembled after an audit begins.

One boundary worth flagging: multinational groups with annual revenue of $850 million or more also face Country-by-Country reporting on Form 8975, which breaks down revenue, profit, taxes, and employees by jurisdiction.¹⁰ Most filers won’t hit that threshold.

Real Estate Purchases Financed With a Mortgage

Tax disclosure is only half the story if you’re buying property from a relative with a mortgage. Lenders have their own rules, and they affect how much you can borrow.

FHA Loans

FHA calls these “identity-of-interest transactions” and caps the maximum loan-to-value ratio at 85% for a principal residence. That means a 15% down payment instead of the usual FHA minimum of 3.5%.¹¹

Several exceptions restore the standard LTV. The cap doesn’t apply if you’re buying the principal residence of a family member, or if you’re a tenant who has been renting the property for at least six months before signing the purchase contract (with a lease to prove it). Builder employees purchasing a model home and corporate relocation transfers also qualify for relief.¹¹

Conventional Loans

Fannie Mae allows non-arm’s length purchases of existing properties but draws two hard lines. Delayed financing (buying with cash and immediately taking out a mortgage) is not permitted for non-arm’s length sales. And for newly constructed homes, Fannie Mae will purchase a loan only if it’s secured by a principal residence and the borrower has an ownership interest, employment, or business affiliation with the builder or developer. Second homes and investment properties are excluded.¹²

Appraisal

Whatever the loan type, the relationship between buyer and seller has to be disclosed to the appraiser and noted on the appraisal report. Lenders scrutinize these appraisals more carefully, so an independent, well-supported valuation is your best protection against a denial or tighter terms.

Documentation You Need Before Filing

The IRS focuses on the gap between your actual price and the market benchmark. If your file can’t explain that gap, you’ve invited an adjustment. For any non-arm’s length transaction, pull together:

Full legal names, addresses, and Taxpayer Identification Numbers or EINs for every party.
A description of what was transferred: tangible goods, intangible property (patents, trademarks, licenses), services, financing, or real estate. For loans, record the principal, the repayment schedule, and the stated rate.
The actual terms agreed on, including the sale price, royalty rate, interest rate, or fee.
The arm’s length benchmark. For real property, a qualified appraisal. For corporate transactions, a transfer pricing study using one of the accepted methods. For loans, the AFR published for the month the loan was made.
Written contracts, intercompany agreements, loan documents, and any amendments. These should exist in writing and predate the transaction.

Filing and Fixing Mistakes

Non-arm’s length disclosures ride along with your tax return rather than going in separately. Form 5472 and related schedules attach to Form 1120. Form 709 is filed with or alongside your Form 1040 by the same deadline. Most of this transmits electronically as part of the standard return package.

If you discover an original filing was incomplete or wrong, file an amended return. Corporations use Form 1120-X; individuals use Form 1040-X.¹³ Corporations generally have three years from the original filing date, or two years from the date the tax was paid, whichever is later.¹⁴ Correcting a problem before the IRS finds it during an audit can reduce or eliminate penalties, so don’t sit on a known error.

What It Costs to Skip the Disclosure

Form 5472 carries a flat $25,000 penalty for each related party for each tax year you fail to file or maintain required records.¹⁵ If the IRS sends you a notice and you still haven’t fixed it within 90 days, an additional $25,000 kicks in for every 30-day period the failure continues after that window closes.⁸ A single-member LLC owned by a foreign individual that ignores the form for two years can face six figures in penalties before anyone looks at the underlying tax.

Separate accuracy-related penalties apply when the prices you reported on related-party transactions are significantly off. A “substantial valuation misstatement” occurs when the transfer price you claimed is 200% or more of the correct arm’s length price, or 50% or less. It can also be triggered when net transfer pricing adjustments for the year exceed $5,000,000 or 10% of gross receipts. The penalty is 20% of the resulting tax underpayment.¹⁶

If the distortion is extreme, meaning the price is 400% or more of the correct amount or 25% or less, it becomes a “gross valuation misstatement” and the penalty doubles to 40%.¹⁶ At that point the IRS tends to treat the whole transaction as suspect. An auditor might recharacterize an interest-free shareholder loan as a taxable dividend, or reclassify a discounted property sale as a capital contribution. Once the reported terms stop matching economic reality, the structure you chose stops controlling the tax result.

1
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
2
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
3
Internal Revenue Service. Applicable Federal Rates
4
Internal Revenue Service. About Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return
5
Internal Revenue Service. Frequently Asked Questions on Gift Taxes
6
Internal Revenue Service. What’s New – Estate and Gift Tax
7
Office of the Law Revision Counsel. 26 US Code 482 – Allocation of Income and Deductions Among Taxpayers
8
Internal Revenue Service. Instructions for Form 5472
9
eCFR. 26 CFR 1.482-1 – Allocation of Income and Deductions Among Taxpayers
10
Internal Revenue Service. About Form 8975, Country by Country Report
11
U.S. Department of Housing and Urban Development. HUD Handbook 4000.1 – FHA Single Family Housing Policy Handbook
12
Fannie Mae. Purchase Transactions – Fannie Mae Selling Guide
13
Internal Revenue Service. About Form 1120-X, Amended US Corporation Income Tax Return
14
Internal Revenue Service. Instructions for Form 1120-X
15
Office of the Law Revision Counsel. 26 USC 6038A – Information With Respect to Certain Foreign-Owned Corporations
16
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments