Study Unit 10: Related Parties, Business Property, and Installme

Larry sold stock with a cost basis of $10,500 to his son for $8,500. Larry cannot deduct the $2,000 loss. His son sold the same stock to an unrelated party for $15,000, realizing a gain. What is his son’s reportable gain?

• 
  $6,500.

• 
  $4,500.

• 
  $2,000.

• 
  No gain.

Answer explanation

Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include a father and a son. Larry realized a $2,000 loss on the sale but may not deduct it. On the subsequent sale, his son realized a $6,500 gain. However, he recognizes only a $4,500 reportable gain. The disallowed loss is used to offset the subsequent gain on the sale of the property ($6,500 realized gain – $2,000 disallowed loss).

Jim sells stock that he purchased in 2009 to his brother John for a $500 loss. He also sells a truck purchased in 2020 to ABC Corporation, his 100%-owned C corporation, for a profit of $800, including $500 of depreciation recapture. What is the effect of these transactions on Jim’s 2022 tax return?

• A loss of $500 on the stock and no gain on the truck.

• A disallowed loss on the stock, $500 ordinary gain, and $300 long-term capital gain on the truck.

• A loss of $500 on the stock and $800 ordinary gain on the truck.

• A disallowed loss on the stock and $800 ordinary gain on the truck.

Answer explanation

The loss on the sale of a capital asset (such as stock) is not allowed when sold to a member of the individual’s family [Sec. 267(b)]. Capital gain treatment is denied when depreciable property is sold between related taxpayers [Sec. 1239(a)]. This rule pertains to sales or exchanges between the following:

1. 1. A person and all entities controlled by such person

2. 2. A taxpayer and any trust of which the taxpayer is a beneficiary unless the beneficiary’s interest is because of a remote possibility to a contingency

3. 3. An executor of an estate and a beneficiary of the estate, unless the sale or exchange is in satisfaction of a monetary value bequeathed to the beneficiary (Sec. 1293)

Robert sold his Lebec Corporation stock to his sister Karen for $8,000. Robert’s cost basis in the stock was $15,000. Karen later sold this stock to Dana, an unrelated party, for $15,500. What is Karen’s realized gain?

• $500

• 
  $7,000

• 
  $7,500

• 
  $0

Answer explanation

Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Brothers and sisters are related parties. Robert realized a $7,000 ($15,000 cost basis in stock – $8,000 sales price to Karen) loss on the sale but may not deduct it. On the subsequent sale, Karen realized a $7,500 gain ($15,500 sales price – $8,000 basis). However, she does not have to recognize the entire gain because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property. Karen would recognize a $500 gain.

Geena paid $10,000 for stock in a start-up company. A few months after she bought it, she sold the stock to her brother Henry for $8,000, its current value. Later, he sold the stock to an unrelated party for $15,000. What gain or loss should Geena and Henry recognize on their tax returns in the year of sale?

• 
  Geena recognizes $2,000 loss; Henry recognizes $7,000 gain.

• 
  Geena recognizes $2,000 loss; Henry recognizes $5,000 gain.

• Geena recognizes $0 loss; Henry recognizes $7,000 gain.

• 
  Geena recognizes $0 loss; Henry recognizes $5,000 gain.

Answer explanation

Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Siblings are related parties for this purpose. Thus, Geena’s loss of $2,000 ($10,000 stock – $8,000 sales price to Henry) on the sale of the stock is disallowed. On the subsequent sale, Henry realized a $7,000 gain ($15,000 sales price – $8,000 basis). However, he recognizes only a $5,000 gain [Sec. 257(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($7,000 realized gain – $2,000 disallowed loss).

In May of the current year, Automatic, Inc., sold land with a basis to Automatic of $10,000 to Jack, its 60% shareholder, for $8,000. In July, Jack sold the land to an unrelated party for $11,000. What is the amount of Jack’s recognized gain?

• 
  $0

• $1,000

• 
  $2,000

• 
  $3,000

Answer explanation

Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Automatic, Inc., realized a $2,000 loss ($10,000 basis – $8,000 sales price to Jack) on the sale but may not deduct it. On the subsequent sale, Jack realized a $3,000 gain ($11,000 sales price – $8,000 basis). However, he recognizes only a $1,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($3,000 realized gain – $2,000 disallowed loss).

Mark owned 100% of the stock in Gathers Corporation. In 2022, Gathers Corporation sold a computer with an adjusted basis of $5,000 and a fair market value of $8,000 to Mark’s Uncle Seth for $4,000. What is the amount of Gathers Corporation’s deductible loss on the sale of this computer in 2022?

• 
  $(4,000)

• 
  $(3,000)

• $(1,000)

• $0

Answer explanation

Tax laws limit tax avoidance between related parties. Losses realized on sale or exchange of property to a related person is not recognized. The transferee takes a cost basis. Uncles, however, are not considered related parties for federal income tax purposes. Gathers may recognize a loss on the sale of $1,000 ($4,000 selling price – $5,000 basis).

Mr. Smith decided to retire from his business in 2022. Included in his assets was a large delivery truck for which he had paid $35,000 in 2018. Mr. Smith had offers to buy his truck for $25,000 from two local truck dealers. He decided instead to sell his truck for $15,000 to his long-time employee, John Pine, as partial compensation for John’s helping Mr. Smith wind up his business. What is John’s basis in the truck?

• 
  $35,000.

• $25,000.

• $15,000.

• 
  None of the answers are correct.

Answer explanation

If an employer transfers property to an employee at less than its fair market value, whether or not the transfer is in the form of a sale or exchange, the difference may be income to the purchaser as compensation for personal services (Reg. Sec. 1.61-2). The basis of the property will be the amount paid increased by the amount included in income as compensation. John will recognize $10,000 ($25,000 FMV – $15,000 paid) of income on the employee bargain purchase. His basis will be $25,000 ($15,000 cash paid + $10,000 income recognized).

Frank sold his Ranier Corporation stock to his sister Bernie for $8,000. Frank’s cost basis in the stock was $15,000. Bernie later sold this stock to Wendy, an unrelated party, for $15,500. What is Bernie’s recognized gain or loss?

• $500

• $(7,000)

• 
  $7,500

• 
  $0

Answer explanation

Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Brothers and sisters are related parties. Frank realized a $7,000 ($15,000 basis – $8,000 sales price to Bernie) loss on the sale but may not deduct it. On the subsequent sale, Bernie realized a $7,500 gain ($15,500 sales price – $8,000 basis). However, she does not have to recognize $7,000 of the gain because the Sec. 267(d) disallowed loss is used to offset the subsequent gain on the sale of the property ($7,500 realized gain – $7,000 disallowed loss = $500 recognized gain).

In April 2022, Pamela sold stock with a cost basis of $15,000 to Lisa, her sister, for $10,000. In September 2022, Lisa sold the same shares of stock to their cousin, Niki, for $8,000. What is the amount of Pamela’s deductible loss for 2022?

• $0

• $2,000

• $5,000

• $7,000

Answer explanation

Under Sec. 267, losses are not allowed on sales or exchanges of property between related parties. Sisters are related parties for this purpose. Thus, Pamela’s loss of $5,000 on the sale of stock is disallowed.

In February 2022, Auto Repair, Inc., sold a car with a basis of $12,000 to Mark, its 55% shareholder, for $10,000. In June 2022, Mark sold the car to an unrelated party for $15,000. What is the amount of Mark’s recognized gain?

• $0

• $2,000

• $3,000

• $5,000

Answer explanation

Under Sec. 267(a)(1), losses are not allowed on sales or exchanges of property between related parties. Related parties include an individual and a corporation in which the individual owns more than 50% of the outstanding stock. Auto Repair, Inc., realized a $2,000 loss ($12,000 basis – $10,000 sales price to Mark) but may not deduct it. On the subsequent sale, Mark realized a $5,000 gain ($15,000 sales price – $10,000 basis). However, he recognizes only a $3,000 capital gain [Sec. 267(d)]. The disallowed loss is used to offset the subsequent gain on the sale of the property ($5,000 realized gain – $2,000 disallowed loss).