What are the tax consequences of selling property at a loss to a relative? It’s good that you checked before going ahead with the transaction-special tax rules make it a very bad idea. In a nutshell, you will not be able to claim the loss and neither will the relative-buyer.

Congress was concerned about taxpayers taking tax losses on sales of their property while essentially retaining control and ownership of the property through a close family member. Accordingly, the tax law provides that no loss can be claimed on any sale of property to a relative. What’s more, this rule applies even if there is no intent to avoid taxes and there is no control over the sold property (say, you are on bad terms with the relative-buyer. This fact doesn’t change the no-loss-permitted rule).

To make matters worse, the loss is “lost“ forever. That is, the loss is not retained in the property and cannot be claimed by the relative if he sells it later. The only benefit the relative may enjoy is that his gain, if any, on a later sale will be reduced by the previously disallowed loss, as illustrated below.

For purposes of these rules, “relative“ means spouse, parent (or grandparent), child (or grandchild), and brother or sister. The loss disallowance rules do not apply to sales to other relatives; i.e., cousins, nieces and nephews, aunts and uncles, or in-laws. (A sale of loss property to an entity such as a corporation you control, a partnership in which you hold an interest, or certain trusts and estates, will also be subject to the loss disallowance rules.)

 Example (1): Jack sells an asset to his sister Jill for $10,000. Jack’s basis in the asset was $15,000. Jill sells it for $10,000 to an unrelated third party. Jack cannot claim his $5,000 loss because the buyer was his sister. Despite this, Jill’s basis is just $10,000: her cost. Thus, when she sells the asset for $10,000 she doesn’t get the tax benefit of the loss either.

 Example (2): The facts are the same as in Example (1) except that Jill sells the asset for $17,000 (it appreciates in value after she buys it). In this case, even though Jill’s basis in the asset is her $10,000 cost, she only has to report $2,000 of her $7,000 gain. The $5,000 loss disallowed to Jack reduces Jill’s gain. Note, interestingly, that while Jack is “penalized“ with a loss disallowance, Jill benefits from his misfortune.

 Example (3): The facts are the same as in Example (1) except that Jill sells the asset for $7,000 (it goes down in value after she buys it). Here, Jill can claim a $3,000 loss based on her $10,000 basis. While the $5,000 loss that accrued to Jack is “lost,“ any drop in value that occurs after Jill buys the asset can be claimed by Jill when she sells it.

Nor can the disallowance rule be avoided by setting up a “straw“ person, for example, selling the property to a non-relative who just owns it briefly before reselling it to the original seller’s relative. That’s because the no-loss rules apply to “indirect“ sales as well.