Disallowed Losses - Sales to Related Parties

This year the stock market and the real estate markets have been strong. As we get to the end of the year, investors start looking for losses to claim. From time to time, we have had the difficult task of explaining to clients who felt they had "developed" the perfect plan to gain a tax deduction by selling a piece of property at a loss to a relative. But it does not work - I.R.S. Code Sec. 267 specifically disallows losses on sales to related parties.

Congress felt there is simply too huge a potential for abuse. Family members could continually “sell” property between themselves at a loss until all losses are realized. For example, Taxpayer A owns a farm that he inherited from his uncle and has no intention of ever allowing it to leave the family.  His inherited basis in the property is $300,000, but he decides to "sell" it to his brother for $200,000 and thereby, gain himself a $100,000 tax write-off.  After several years, his brother "decides he no longer wants it" and sells it back to Taxpayer A for, now, $100,000 gaining himself a $100,000 write-off, also! Those losses are strictly disallowed.

It does not matter that the asset is being sold for its actual fair market value. And the Tax Court has ruled that family hostility may not be considered; losses between proscribed family members are disallowed in all cases.

Section 267 not only applies to family members, but also includes related businesses, trusts, fiduciaries, etc as defined:

    Members of a family, including brothers and sisters, spouse, ancestors (e.g., parents, grandparents), and lineal Descendants (children, grandchildren).

    An individual and a corporation where more than 50% of the stock is owned directly or indirectly by that individual. (Indirectly means, for example, that stock owned by your children can be deemed owned by you.)

    Two corporations which are members of the same controlled group (e.g., common ownership).

    Certain relationships between trusts, grantors, fiduciaries and beneficiaries of such trusts.

    A corporation and a partnership if the same persons own more than 50% of the stock of the corporation and more than 50% of the profits or capital interest of the partnership.

    An S corporation and another S corporation if the same persons own more than 50% of the stock of each corporation or an S corporation and a C (regular) corporation if the same persons own more than 50% of the stock in each.

    Even if you actually own less than 50%, for the purpose of this rule, you may be held to own all the stock that your family members own. This is known as the "constructive ownership rule."

   There are related parties other than the ones listed above as well.  What exactly constitutes a related party can sometimes be a gray area and you should certainly contact us first if you think there may be some risk to a particular transaction you are planning.


  We advise our clients to avoid related party transactions at all times if possible.  Gains and losses on related party transactions cannot be netted. The gains on a related party transaction are generally recognized, but losses are not; all of the "gain" items are added up and reported on your tax return, but all of the "loss" items are not.

  Also, the disallowed loss on a related party transaction isn't always recaptured upon a subsequent sale by the other party.  For example, if you own shares of Company X with a $20,000 basis and you sell those shares to your sister for $10,000, you obviously cannot take the $10,000 loss you incurred under the related party rules.  If your sister then sells the shares for $30,000, she will recognize only the $10,000 gain between your $20,000 basis and her $30,000 proceeds. (Provided she is aware of these rules and gets and keeps your records.)

  However, if she later sells the shares for only $5,000, her loss will only be the difference between the $10,000 she paid you and the $5,000 in proceeds. The $10,000 you lost on the sale to her will never be deducted by either of you!

Indirect sales will not work either: for example, sell a piece of property to an unrelated party (a non-relative friend) who then turns around and re-sells the property to your related party. Sec. 267 also applies to "indirect" transfers.  The I.R.S. can simply "look through" the transaction and disallow the loss.

And what happens if the friend in the example above doesn't re-sell the property to a related property?  Well, the related party rules can still bite you if the I.R.S. deems that the price appears to be artificially low and could not reasonable have been an "arm's length" transaction.  Yes, even friends can be related parties if the deal looks suspicious.

As you can see, there are a lot of "traps" in the related party rules.  We encourage you to call our office if you are considering a transaction that could even remotely be considered a related party transaction. 


Asset Protection Tips

Asset Protection Tips In Today’s Litigious World

            All of us are concerned about that unexpected claim. Here are some things you can do

   1. Liability Insurance is your first line of defense, buy every type and dollar you can afford,  including umbrella policies. The value of the insurance provided defense is often much more important to you than the indemnity. 

  2. Pay all your taxes, especially employment taxes. Don’t try to characterize true employees as independent contractors. The I.R.S. has the best collectors and onerous penalties.

    3. Use limited liability entities such as corporations, LLCs and limited partnerships as liability firewalls. Divide and legally segregate your personal, investment  & business assets (and liabilities). But a single LLC owning several investment assets permits an exposure from one to jeopardize the equity in the others.

  4. Use multiple entity planning. Most creditors do not have the knowledge, resources, and time to penetrate multiple entity structures. While the cost and effort to establish and maintain multiple entities is greater, the protection afforded is significantly increased. If you alone own an entity, run it, and control it, creditors may argue that it is still YOU. Because of the lack of required formalities, a single owner LLC may be pierced. 

  5. Make the extra effort to respect the entities and arrangements you create. Sign contracts with correct titles. Use the appropriate checks and letterhead. Make your actions consistent with your documents and with normal third party practices. Record the deeds. Pay the rent or interest due, when scheduled; at least square things up annually.

   6. Get professional legal, accounting and bookkeeping help to organize your assets and maintain the legal entities formalities including filing tax returns, meeting minutes, separate bank accounts, promissory notes, sale and loan agreements, etc.

    7. Pay attention to what your business co-owners do in the name of the business. Don’t let your partner or co-owner own “her” vehicle in your jointly owned business, particularly if it owns valuable assets. Vehicles are a source of significant liability. If an owner or her spouse injures someone with a company-owned car, she has created a "bridge" not only to your business and all it owns, but to your interest in it as well. Take a vehicle allowance instead of trading a tax deduction for extra liability.

   8. If you have employees, put professional employment manuals, policies and dispute resolution agreements in place. A small investment with an employment lawyer will cover your business and family for years. You are significantly more likely to be sued by an employee than by anyone else.

  9. Be generous, completed gifts (but not fraudulent transfers in the face of known liabilities) will be enjoyed by other people you select, not those who sue you. And friends and relatives who received your gifts may one day loan you money or help you out. But in undertaking asset protection, don’t make yourself so illiquid you cannot operate. Don’t make yourself insolvent.

 10. If you are uncomfortable with large gifts, consider “freezing” your assets. For example, sell property to your children for a long term note and rent it back at fair rental value. Let them have the future appreciation. Tax consequences can be controlled to a large extent, if you plan carefully.

  11. Be nice to everyone as a rule. During difficult economic times people are much more likely to take legal action, whether justified or not. Your bedside manner will play a role in their emotional decision to sue you. Our culture has changed. We are living in a world of “blame the other guy.” And litigation is expensive both cost wise and from an emotional point of view.

    12. Do Something TODAY. Every day that passes makes transfers and actions you take to protect your assets stronger and harder to argue with. Trying to protect yourself after you have a liability event is much more difficult and may be ineffective.   Be less of a target. Own less or nothing. You don't need to keep assets in your own name to use, control and enjoy them. Make use of trusts, corporate shells and family members to transfer title to assets away from you.



What to Keep in a Safe Deposit Box

A safe-deposit box is a secure place for items that would cause panic if lost, cannot be easily replaced and items easily stolen. The annual rent for a safe-deposit box depends on what size box you need. A safe deposit box is best used to securely store papers and small valuable, portable investments.


What to Keep in a Safe-Deposit Box

    * Insurance policies: casualty, liability, health, (or at least the declarations page)

    * Insurance policies: life, disability, long term care ( best to protect whole policy)

    * Vehicle titles [“pink slips”]

    * Stock and bond certificates and copies of DRP and evidence of direct registration of shares or bonds.

    * Cash, valuable coins, bullion and jewelry

    * Valuable small collectibles, when not on display

    * Promissory notes, other original evidence of contracts &items due to you or owned by you.

    * Important original signature documents entrusted to you (keep copies at home/work)

    * A videotape, DVD or the like of an inventory of your home and all its contents

    * A list of all your account numbers, usernames, passwords, PINs, etc.

    * Evidence of provenance of collectibles

     * Back-up copies of cost basis information for all investments and major assets, including copies of Federal Estate Tax Returns that describe assets you have inherited

    * Back-up copies of passports, driver’s licenses, credit cards, bank passbooks

    * Back-up copies of evidence of bank and other deposit accounts, CDs,

    * Back-up copies of appraisals, especially of tangible personal property /collectibles

    * Birth, marriage and death certificates

    * Adoption papers and divorce decrees

    * Deeds, mortgage papers and lease contracts

    * Military records and citizenship papers

     * Anything else you’d not be able to replace & really miss if everything in your house burned.


What NOT to Keep in a Safe-Deposit Box, UNLESS you give someone else who you trust full access to your Safe-Deposit Box in accordance with the bank’s rules:

    * Anything you might need quickly in an emergency, such as

                * Power of attorney documents

                * Medical care directives

                * Funeral or burial instructions

                * Emergency, “mad money” cash

   * Originals of wills, trusts and other estate planning documents

   * Safe-Deposit Box keys to other safe-deposit boxes, safes, storage containers, etc.


            So what should you do with your important items that you do not keep in a safe-deposit box? Store them in a safe place at home, possibly a fireproof/waterproof safe, where they are more easily accessible in a hurry. Let trusted people know where you put them. Consider giving copies of all important documents to a close relative or friend. More important, make certain whoever you've appointed in your Durable Power of Attorney and Advance Medical Directive knows he or she has been appointed and where the originals are.


Quick Tips: As a precautionary measure, keep a separate list of the items in your safe-deposit box and make a habit of going to and checking the box at least once a year-if only to keep from forgetting where you hid the key. Give someone a sealed envelope that reveals where you put the key. If you move, make sure you change your address on file with the bank where you rent your safe-deposit box. 


What is the Role of the Trustee?

Trustee’s Role

Many people agree to administer a trust without having the slightest idea of what it entails. Most believe it to be a simple matter of distributing the trust assets, but it involves much more. A trustee assumes a fiduciary relationship with the beneficiaries of a trust and, as discussed belowe “A Trustee’s Fiduciary Responsibility,” there is an extensive array of legal duties and obligations imposed on a trustee. As a general rule, administering a trust is a fairly formal process in which the trustee must undertake the distribution the trust assets without the benefit of court guidance. If the trustee does not follow the rules of fiduciary responsibility, the trustee may subject the trust to loss and damage, and may incur personal liability in some instances. The trustee must always put the interests of the beneficiaries ahead of the those of the Trustee. If the Trustee is also a beneficiary, those rights cannot come first, but must be at most strictly equal.


In administration, the trustee must take control of the trust assets including real and personal property as well as various financial and investment accounts. Properties must be managed. Management may be directed by the terms of the trust, but if the trust is silent, there are laws in California that govern the management of a trust. There are notices that should be given including a notice to beneficiaries and heirs and a separate notice to creditors.


The trustee has a duty to keep the beneficiaries informed about the administration of the trust. The trustee should keep detailed records of all assets that are in the trust, all income received, and all expenses of the trust. A trustee has an obligation to see that all tax returns required are filed and all taxes are paid. A trustee should consult appropriate professionals such as an accountant and an attorney during the administration of the trust.


Many people feel honored to be asked to serve as a trustee of a trust without realizing the responsibility it entails. A trustee has a legal relationship with the beneficiaries of a trust. This legal relationship imposes many duties and obligations on the trustee.


Among these duties are the duty:

    * to act with a high standard of care,

    * to gather, manage and control the trust assets,

    * of loyalty to all parties,

    * to avoid a conflict of interest,

    * to treat all beneficiaries equally,

    * to carry out the terms of the trust, and

    * to invest and manage assets in accordance with the terms of the trust and the law.


A trustee must take care to avoid co-mingling the assets of the trust with the trustee’s own assets, or with those of other trusts. A trustee must be prepared to report to the beneficiaries to keep them informed of the trust’s activities and a trustee generally will have a duty to account to the beneficiaries for the assets, the income, and the expenses of the trust, including any fees he charges..


These are just a few of the many legal duties and obligations imposed on a trustee.