Related-Party Transaction Rules: Tax Implications of Business Deals with Family and Partners

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated October 18, 2026 ·7 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

The IRS applies heightened scrutiny to transactions between related parties because the parties can set prices, terms, and timing to shift income and deductions in ways that reduce total tax. Under IRC 267, losses on sales or exchanges between related parties are disallowed. Under IRC 7872, below-market loans between related parties create imputed interest income to the lender. Under IRC 482, the IRS can reallocate income, deductions, and credits between commonly controlled entities to prevent tax avoidance. These rules apply to transactions between family members, between a shareholder and their corporation, between two corporations owned by the same person, between a partner and their partnership, and between trusts and their beneficiaries.

✓Key takeaway

Who is a “related party” under IRC 267?

Family members:

Spouse
Brothers and sisters (including half-siblings)
Ancestors (parents, grandparents)
Lineal descendants (children, grandchildren)
NOT included: aunts, uncles, cousins, in-laws, step-siblings (unless adopted)

Entity relationships:

Individual and their controlled corporation (more than 50% ownership)
Two corporations in the same controlled group (more than 50% common ownership)
Partner and their partnership (for certain transactions)
Individual and their trust (grantor, fiduciary, or beneficiary)
Two S-Corps owned by the same individual
An S-Corp and its shareholder (for loss transactions)

Key rules:

1. No loss deduction on related-party sales (IRC 267(a)(1)):

Transaction	Tax Treatment
Sell equipment to your S-Corp at a loss	Loss disallowed
Sell property to your child at a loss	Loss disallowed
Sell stock to your spouse at a loss	Loss disallowed
Sell equipment between two LLCs you own	Loss disallowed

The disallowed loss is NOT gone forever. When the related buyer later sells the property to an unrelated party, the gain is reduced by the previously disallowed loss (but only to reduce the gain, not to create a loss).

2. Below-market loans (IRC 7872):

Loan Type	AFR (Applicable Federal Rate) Required
Demand loan	Federal short-term rate
0-3 year term	Federal short-term rate
3-9 year term	Federal mid-term rate
Over 9 years	Federal long-term rate

If no interest is charged (or below-market interest), the IRS imputes interest at the AFR. The lender has imputed interest income, and the borrower has imputed interest expense (deductible only if otherwise deductible).

Exception: loans of $10,000 or less between individuals are exempt from imputed interest rules (unless the loan is used to purchase income-producing property).

3. Matching rule (IRC 267(a)(2)): If a related party uses the accrual method and claims a deduction, but the other party uses the cash method, the deduction is deferred until the cash-basis party actually receives the payment. Common situation: an S-Corp (accrual) deducts a bonus to the owner (cash basis). The deduction is only allowed when the owner actually receives the bonus, not when it’s accrued.

4. Section 1031 exchanges with related parties (IRC 1031(f)): A like-kind exchange with a related party is allowed BUT: if either party disposes of the exchanged property within 2 years, the deferred gain is recognized. This prevents taxpayers from using related-party exchanges to cash out appreciated property while deferring gain.

Hypothetical example

Round numbers. A small business owner with multiple entities and family involvement.

Scenario 1: Selling equipment from personal to S-Corp The owner bought a truck for $40,000 personally. It’s now worth $25,000 (fair market value). The owner sells it to their S-Corp for $25,000.

Without related-party rules: $15,000 loss ($40,000 basis - $25,000 sale price), deductible only if the truck was used in a business or held for profit (a loss on a personal-use vehicle is never deductible).

With related-party rules: loss is DISALLOWED under IRC 267 because the owner and their S-Corp are related parties (more than 50% ownership).

The S-Corp’s basis in the truck: $25,000 (what it paid). When the S-Corp later sells the truck to an unrelated buyer for $18,000:

S-Corp loss: $25,000 - $18,000 = $7,000 (the S-Corp’s own loss, measured from what it paid)
Previously disallowed loss: $15,000
IRC 267(d) only reduces a later gain, and this sale produces a loss, so none of the $15,000 can be used
The original owner’s entire $15,000 disallowed loss is permanently lost

Lesson: don’t sell property that has dropped in value to your own entity at a loss. If you want the loss, sell it to an unrelated party.

Scenario 2: Renting property to your S-Corp The owner owns a commercial building personally and rents it to their S-Corp for $3,000/month ($36,000/year).

Fair market rent for the area: $2,500/month.

IRS concern: the owner is inflating the rent to shift income from the S-Corp (subject to FICA if paid as salary) to the rental (not subject to FICA or SE tax if a passive landlord).

The $500/month excess ($6,000/year) could be recharacterized as:

Additional compensation (subject to FICA)
A disguised distribution (if the S-Corp deduction is disallowed)
An economic substance challenge

The safe approach: document the fair market rent with comparable listings, use a formal lease agreement, and stay at or below market rates.

If the rent is BELOW market ($2,000/month vs. $2,500 FMV):

The S-Corp gets a smaller deduction ($24,000 instead of $30,000)
The owner has less rental income ($24,000)
The IRS is less likely to challenge a below-market rent (it doesn’t reduce total tax)
But: below-market rent can create a shareholder benefit issue (the S-Corp is giving the shareholder-landlord a sweetheart deal)

Scenario 3: Loan from owner to S-Corp (no interest) The owner lends $50,000 to their S-Corp. No interest is charged. The loan is repayable in 5 years.

IRC 7872 analysis:

Mid-term AFR (for 3-9 year loan): 4.61% for October 2026 (the rate changes monthly)
Because this is a term loan, the forgone interest is figured up front: $50,000 minus its present value at the AFR, about $10,100, is treated as transferred to the S-Corp on the day of the loan
That amount then comes back as imputed interest (original issue discount): roughly $1,800 in year one, rising to about $2,200 in year five
The owner reports that imputed interest as income each year, and the S-Corp deducts it as interest expense (if it meets IRC 163 requirements)

For most small S-Corps, the imputed interest is a wash (income to the owner, deduction to the S-Corp, same tax bracket). But it creates paperwork and reporting obligations.

The fix: charge interest at least at the AFR in effect when the loan is made (4.61% mid-term for October 2026) and document the loan with a promissory note.

Scenario 4: Employing spouse, parent, or child (legitimate) Hiring family members IS allowed and can produce significant tax benefits (see hiring family article). The related-party rules don’t prohibit employment; they require:

Real work performed
Reasonable compensation (not inflated to shift income)
Proper documentation (timesheets, job description)
Compliance with employment tax rules

Scenario 5: Two S-Corps owned by the same person Owner has S-Corp A (consulting) and S-Corp B (real estate). S-Corp A charges S-Corp B $5,000/month for administrative services.

IRC 482 issue: the IRS can reallocate income between commonly controlled entities if the pricing doesn’t reflect arm’s-length terms.

If comparable administrative services cost $3,000/month from an unrelated provider:

The IRS can reduce S-Corp B’s deduction to $3,000/month
The IRS can reduce S-Corp A’s income correspondingly (or increase it, if the allocation favors A)
The $2,000/month difference may be recharacterized as a distribution from B to the owner, then a contribution from the owner to A

Documentation: get a quote from an unrelated provider for comparable services. Price the inter-company service at or near that quote. Keep a written service agreement between the two entities.

Illustrative numbers only, not a real client and not advice for your facts.

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Cite this page

Yarik Yarosh, CPA. "Related-Party Transaction Rules: Tax Implications of Business Deals with Family and Partners." Blue Cloud CPA, September 5, 2026, updated October 18, 2026. https://bluecloudcpa.com/guides/small-business-related-party-transaction-rules-tax

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.

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