What Is a Related Person for Tax Purposes?

A related person for tax purposes is someone whose connection to you — by family, business ownership, or a trust or estate relationship — is close enough that the Internal Revenue Code assumes a transaction between you may not reflect an arm’s-length price. When two related persons deal with each other, losses can be disallowed, deductions delayed, and gains that would normally qualify for capital gains rates recharacterized as ordinary income.

Which Family Members Count

The tax code’s definition of family is narrower than most people expect. For related-person purposes, your family includes only your spouse, your brothers and sisters (including half-siblings), your ancestors (parents, grandparents, and so on), and your lineal descendants (children, grandchildren, and so on).¹

Cousins, in-laws, aunts, uncles, nieces, nephews, and step-relatives are all left out. The statute uses the word “only” before its list, so anyone not named is treated as unrelated. Sell property to your cousin at a loss and the loss is deductible. Sell the same property to your brother at a loss and it is not.

The relationships apply regardless of whether the family members get along. The law looks at the legal or biological link, not the quality of it. Estranged siblings still count. A parent who hasn’t spoken to a child in decades still counts.

Businesses You Control

Beyond family, you are a related person to any business you effectively control. You and a corporation are related if you own more than 50 percent of the corporation’s stock by value, directly or through the constructive ownership rules described below.¹ The same more-than-50-percent threshold applies to partnerships, measured by either capital interest or profits interest.²

Combinations of entities owned by the same people also fall inside the net. Two corporations belong to the same “controlled group” when the ownership links between them exceed 50 percent; the code borrows the controlled-group framework from a separate provision that normally uses an 80-percent threshold, and substitutes more than 50 percent for related-person purposes.¹ Other combinations treated as related include a corporation and a partnership when the same people own more than 50 percent of each, two S corporations under the same ownership test, and an S corporation paired with a C corporation on the same terms.

Trusts, Estates, and Charities

Trusts create several layers of related-person status. A grantor is related to the trust’s fiduciary. A fiduciary is related to the trust’s beneficiaries. When one person creates two separate trusts, the fiduciaries of those trusts are related to each other, and each trust’s fiduciary is related to the other trust’s beneficiaries.¹

These links stop a grantor from moving assets across multiple trusts while keeping effective control. Without them, someone could sell property from Trust A to Trust B at an artificial loss, claim the deduction, and still benefit through a beneficiary interest in Trust B.

A trust and a corporation are related if the trust or its grantor owns more than 50 percent of the corporation’s stock.¹ Estates work similarly. An executor and a beneficiary of the same estate are related persons, with one exception: a sale made to satisfy a specific dollar bequest. A person who controls a tax-exempt charitable or educational organization is related to that organization.

Constructive Ownership Rules

You do not need to hold stock in your own name to be treated as an owner. Constructive ownership rules attribute stock to you from three sources: entities you have an interest in, your family members, and your business partners.

Stock owned by a corporation, partnership, estate, or trust is treated as owned proportionally by its shareholders, partners, or beneficiaries. If a partnership owns 100 shares of a corporation and you hold a 40-percent partnership interest, you are treated as owning 40 of those shares. That attributed ownership is treated as if you actually hold the stock, so it can be attributed further to your family or partners.³

Family attribution works differently. You are treated as owning any stock held by your spouse, siblings, ancestors, or lineal descendants. But stock you pick up through family attribution cannot be passed along again to another family member or partner. The same limit applies to partner attribution: stock attributed to you because your partner owns it stops with you.³

The math surprises people. Suppose a husband directly owns 30 percent of a corporation and his wife directly owns 25 percent. Through family attribution, each spouse is treated as owning the other’s shares. Both are now treated as owning 55 percent, which puts each of them over the 50-percent threshold and makes both related persons to the corporation. Partnership ownership is measured under the same framework.²

Losses Are Disallowed

The most common consequence of related-person status is losing a deduction. When you sell property at a loss to a related person, you cannot deduct that loss.¹ The rule reaches direct and indirect sales, and it does not matter whether you intended to avoid tax or simply sold at a fair price that happened to fall below your original cost.

The disallowed loss is not permanently destroyed. When the related buyer eventually sells the property to an unrelated party at a gain, that gain is recognized only to the extent it exceeds the previously disallowed loss.⁴ The buyer effectively gets to shelter part of their future gain by the amount of the seller’s disallowed loss. The offset can reduce a gain to zero, but it cannot generate a new deductible loss for the buyer.

Expense Deductions Wait for the Payee

Loss disallowance is not the only trap. When you owe money to a related person for services, rent, interest, or similar expenses, you can deduct that expense only when the related person actually reports the payment as income.⁴

This matters most when the two parties use different accounting methods. If your corporation uses accrual accounting and books an expense in December, but the related payee uses cash accounting and does not receive payment until February, the corporation cannot deduct the expense in December. The deduction shifts to the year the payee includes the payment in income. The rule stops a pair of related parties from accelerating deductions while delaying the matching income.

Gains Can Become Ordinary Income

Selling property to a related person at a gain can carry an unexpected tax cost. When the property will be depreciable in the buyer’s hands, any gain the seller recognizes is treated as ordinary income rather than capital gain.⁵ The difference matters because ordinary income is generally taxed at higher rates than long-term capital gains.

The rule targets a specific planning move: selling a depreciated asset to a related buyer at fair market value so the seller pockets capital gains treatment while the buyer gets a stepped-up basis and fresh depreciation deductions at ordinary-income rates. Recharacterizing the seller’s gain as ordinary income eliminates the rate mismatch.

For this rule, related persons include you and any entity you control by more than 50 percent, you and any trust in which you or your spouse is a beneficiary, and an executor selling to a beneficiary of the same estate.⁶ Ownership is measured by stock value for corporations and by capital or profits interest for partnerships.

Installment Sales and the Two-Year Trap

If you sell property to a related person on the installment method and that buyer resells the property within two years, you lose the benefit of deferring your gain. The amount the buyer receives on the resale is treated as if you received it at the time of the resale, accelerating your gain recognition.⁷

The two-year window applies to most property other than marketable securities, which have no safe harbor at all. The clock can also be paused if the related buyer hedges their risk through put options, short sales, or similar arrangements that reduce economic exposure to the property.⁷

For installment sales, the definition of related person is broader than the standard one. It includes everyone listed under Section 267(b) plus anyone whose stock would be attributed to you under the attribution rules used for corporate redemptions.⁸ Confirm the buyer’s status before structuring the deal, because the resale trigger can generate a tax bill in a year when you have no cash from the sale to pay it.

Reporting Foreign Corporations You Control

Related-person rules also drive reporting requirements. If you own more than 50 percent of a foreign corporation, you must file Form 5471 disclosing that ownership and any transactions between you and the foreign entity. Failing to file carries a penalty of $10,000 for each annual accounting period of each foreign corporation. If the IRS sends a notice and you still do not file within 90 days, an additional $10,000 penalty accrues for each 30-day period of continued noncompliance, up to a maximum of $50,000 in continuation penalties per failure.⁹

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 707 – Transactions Between Partner and Partnership
3
eCFR. 26 CFR 1.267(c)-1 – Constructive Ownership of Stock
4
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
5
Office of the Law Revision Counsel. 26 USC 1239 – Gain From Sale of Depreciable Property Between Certain Related Taxpayers
6
Office of the Law Revision Counsel. 26 U.S. Code 1239 – Gain From Sale of Depreciable Property Between Certain Related Taxpayers
7
Office of the Law Revision Counsel. 26 USC 453 – Installment Method
8
Office of the Law Revision Counsel. 26 USC 453 – Installment Method
9
Internal Revenue Service. Instructions for Form 5471