LLC Interest / Related Party Rules

[Maude Lebowski]

I've read Code Sec 267 regarding related-party sales, but I'd like some feedback on my thought process/interpretation.

My client bought 5% interest in an LLC from his son-in-law in 2012. The LLC intended to build a building and planned to get a mortgage, plus borrow $100K each from his father & his father-in-law (my client). The bank wouldn't lend unless the two fathers bought an interest in the LLC, so they each bought a 5% interest in the LLC for $100,000 each.

In 2015, the son-in-law has repurchased my client's 5% for $100,000. My client's basis exceeds $100,000, so the sale is at a loss. Do the related-party rules make the loss non-deductible?

The 2012 Sales agreement was between the son-in-law & my client. My client's daughter doesn't own any part of the LLC directly. I feel like the loss on the sale is deductible because, following the related-party rules, my client does not/did not own any other portion of the LLC directly or indirectly before or after the purchase or sale & the son-in-law did not own any portion of the 5% interest directly or indirectly during the period of my client's ownership. To put it another way, this only works because my client's daughter has no direct interest in the LLC--even though she owns/owned 95% INDIRECTLY--90% via her husband & 5% via her father--that's actually why I hesitate. It seems like it is following rules, but violating the intent.

Is my thinking sound? Anything else I need to consider? (Sale at less than FMV, for example.)

[Golden Rocket]

Thinking is not sound

Maude, your thinking is not sound as the related party rules are violated at every turn.

Firstly, the related party rules extend to spouses. Secondly, he sold the 5% interest directly to his son/son-in-law. The loss unavailable to the father, however, can be added to the buyer's basis.

If the LLC was not 95% owned by the daughter, he could have sold back to the LLC under a structured sale, and then LLC could have issued to son/son-in-law at value.

My opinion only. Maybe others will post.

[Maude Lebowski]

Thanks for your input, Golden Rocket. That's exactly why I'm thinking out loud here. I've been going around in circles within my own head, alternately convinced that it is & then is not a related-party transaction. What was throwing me off, I think, was that neither party directly involved & specifically named in the transaction has any indirect ownership.

I think I get it now: the transaction is considered a related-party transaction because the daughter has indirect ownership, so it plays out, per IRC 267, as a transaction between father & daughter. Is that right?

(And I do understand how the un-allowed loss gets added to the son-in-law's basis if this is a related-party transaction, but thanks for pointing that out.)

[TAXNJ]

Thanks for your input, Golden Rocket. That's exactly why I'm thinking out loud here. I've been going around in circles within my own head, alternately convinced that it is & then is not a related-party transaction. What was throwing me off, I think, was that neither party directly involved & specifically named in the transaction has any indirect ownership.

I think I get it now: the transaction is considered a related-party transaction because the daughter has indirect ownership, so it plays out, per IRC 267, as a transaction between father & daughter. Is that right?

(And I do understand how the un-allowed loss gets added to the son-in-law's basis if this is a related-party transaction, but thanks for pointing that out.)

If you have time consider this to review

http://www.taxlawforchb.com/2013/12/related-party-sales/

[Snaggletooth]

More from You

Maude, I notice this was your first post. Please consider coming back and asking more questions as you feel the need. There are numerous helpful people on this forum.

[Maude Lebowski]

Thanks for the welcome, Snaggletooth. Back when I used Drake, I used to participate in their forum. I found this forum when I switched from Quickfinder to The Tax Book, but I've mostly been lurking so far.

TAXNJ, thank you for the link. Coincidentally, I had already read that post, and believe it or not, it's not what happens once "relatedness" is determined that was throwing me off. Trying to determine if the parties were related was throwing me off.

Language like the following IRC 267 snippets are hard for me to parse without thinking out loud, especially, (5)! If that's not as clear as mud, I don't know what is!:

(b) Relationships

The persons referred to in subsection (a) are:

(1) Members of a family, as defined in subsection (c)(4);

. . . . . . .

(c) Constructive ownership of stock

For purposes of determining, in applying subsection (b), the ownership of stock -

. . . . . . .

(4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and

(5) Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.

[TAXNJ]

One more reference with a possible contact if you have not reviewed

http://www.ccim.com/cire-magazine/articles/irs-clarifies-related-party-rule-1031-exchanges/?gmSsoPc=1

Good luck

[Maude Lebowski]

One more reference with a possible contact if you have not reviewed

http://www.ccim.com/cire-magazine/articles/irs-clarifies-related-party-rule-1031-exchanges/?gmSsoPc=1

Good luck

Thanks, but it's not a 1031 Exchange.

[TAXNJ]

Thanks, but it's not a 1031 Exchange.

Yes but there was a contact. Lastly two more suggestions

http://tax.cchgroup.com/downloads/files/contemporary-tax-practice/Module2/Topic4/A-Sec-267-Related-Party-Definitions-Attribution-Rules.asp

http://www.csa-accounting.com/Ace/Articles/Relatedpartysales.htm

[Maude Lebowski]

In-laws are not related parties

If anyone cares, I was able to determine that in-laws are not related parties under Section 267 of the Code. See Stern V. Commissioner 1954.

[TAXNJ]

If anyone cares, I was able to determine that in-laws are not related parties under Section 267 of the Code. See Stern V. Commissioner 1954.

As long as you care is the important factor. Good job and thanks for sharing.

[Snaggletooth]

Not Necessarily True

If anyone cares, I was able to determine that in-laws are not related parties under Section 267 of the Code. See Stern V. Commissioner 1954.

Maude - don't believe this is necessarily true. The "tree" for related parties invokes the spouse, and vertical kinship of the spouse.

Maude's husband is Claude. Claude's father is Harry. Harry is Maude's father-in-law but he is a related party to Maude.

Maude has a neice, Mary. Mary is NOT a related party, nor is she an in-law.

The tree starts with the taxpayer, and stretches vertically upward and downward to direct ancestors and descendants. It also stretches sideways with brothers and sisters in the immediate family and stops there. However, if the taxpayer marries, the spouse and his tree becomes related parties as well, at least vertically.

[Maude Lebowski]

It's a cross not a tree.

Yes, spouses are related parties, but a related party's spouse is not. Stern V. the Commissioner concerns a father who sold his residence to his son-IN-LAW and the Tax Court determined that they were not related parties.

So Harry, the father-in-law, while a related party to his son, Claude, is NOT a related party to Maude, his daughter-in-law.

To put it another way, the tree goes only vertically & horizontally. Anyone outside of that is not necessarily a related party based on family relationships--they could be when examining other relationships such as common ownership of another entity (corp, partnership, etc.).

Here's a chart I found & which I believe to be a reliable interpretation of Sec. 267(c)(4): http://www.andrewmitchel.com/charts/...ttribution.pdf

[TAXNJ]

Yes, spouses are related parties, but a related party's spouse is not. Stern V. the Commissioner concerns a father who sold his residence to his son-IN-LAW and the Tax Court determined that they were not related parties.

So Harry, the father-in-law, while a related party to his son, Claude, is NOT a related party to Maude, his daughter-in-law.

To put it another way, the tree goes only vertically & horizontally. Anyone outside of that is not necessarily a related party based on family relationships--they could be when examining other relationships such as common ownership of another entity (corp, partnership, etc.).

Here's a chart I found & which I believe to be a reliable interpretation of Sec. 267(c)(4): http://www.andrewmitchel.com/charts/...ttribution.pdf

Well, the United States Court of Appeals Third Circuit ruling and a chart of Sec 267 (pictures are worth a thousand words) seems to provide the best support for your opinion.

[Maude Lebowski]

Thank you for the discussion.

I would rather hash this out with other tax professionals beforehand than with the IRS after I file the return. :-)