Why It Matters
You'll encounter this term when the IRS, a lender, or your LLC's operating agreement needs to know whether a deal was done at arm's length. Regulators scrutinize related-party deals because the connection between buyer and seller can suppress prices, inflate fees, or remove the negotiating tension that produces fair market outcomes. Disclosure is almost always required — and sometimes the deal structure must change or the tax benefit disappears.
At a Glance
- Covers sales, loans, leases, management contracts, and service agreements between connected parties
- Related parties: family members, business partners, co-owners, entities with overlapping ownership
- Section 267 disallows losses on related-party sales — no workaround after closing
- 1031 exchanges into related-party properties require both parties to hold for two full years
- Lenders require non-arm's length disclosure and cap LTV at appraised value, not purchase price
- Syndication PPMs must disclose all related-party fees and arrangements to investors
- Self-dealing by a fiduciary in a related-party deal triggers personal liability
- The transaction isn't automatically void — documentation and disclosure are the fix
- State law and operating agreements may impose additional approval requirements
How It Works
What makes a party "related." Under IRC Section 267: family members (spouse, siblings, parents, children, grandchildren), corporations where you own more than 50% of shares, trusts where you're a beneficiary, and most partnership structures. LLCs you control are related parties to you — selling property from yourself into your own LLC is not an arm's length transaction.
Loss disallowance. If you sell to a related party at a loss, Section 267 disallows the deduction. The loss is suspended until the buyer eventually sells to an unrelated third party — preventing manufactured losses that would never occur between independent sellers.
The 1031 exchange problem. When you exchange into a property sold by a related party, both you and the related party must hold your respective properties for two full years. If either party sells within that window, the exchange is retroactively disqualified. See related-party exchange and qualified intermediary for the mechanics.
Lending and syndications. Conventional lenders require disclosure when buyer and seller are related, order an independent appraisal, and cap financing at appraised value. In syndications, a GP routing fees or contracts to affiliated companies must disclose this in the PPM. Fiduciary duty to LPs requires market-rate pricing or explicit consent, backed by a sound entity structure.
Real-World Example
Kevin decided to sell his Phoenix fourplex to his son Tyler for $395,000 — fair, he thought, without pulling recent comps. Tyler's lender flagged it day one: first-degree relatives. An independent appraisal came back at $418,000, and the lender would only finance 75% — $313,500. Tyler had budgeted $79,000 down and now needed either more cash or a higher purchase price.
Kevin's CPA confirmed the gain: $85,000 above his $310,000 adjusted basis. Had he been selling at a loss, Section 267 would have disallowed it entirely.
They renegotiated to $418,000. Kevin gifted $23,000 back at closing with a gift letter and filed Form 709. Three extra weeks and two professional consultations — the cost of skipping the related-party review upfront.
Pros & Cons
- Related-party deals are legally sound when documented — family transfers, partnership buyouts, and syndication fee arrangements are routine with proper paperwork
- The rules are well-defined; investors who know the playbook can plan around loss disallowance, the two-year 1031 rule, and gift thresholds before problems develop
- Transactions within an LLC can consolidate ownership and reduce costs versus selling on the open market
- Section 267 permanently disallows losses on related-party sales — no workaround after the deed records
- The 1031 two-year holding requirement makes related-party exchanges far riskier; one early sale retroactively wipes the tax deferral
- Non-arm's length status triggers lender scrutiny that can stall closings, reduce loan proceeds, and expose unexpected gift tax obligations
Watch Out
Selling to your own LLC is still a related-party transaction. The IRS sees you controlling both sides. Section 267 applies, and any loss on the transfer is disallowed. Get tax advice before the deed records if a loss is in play.
Syndication management fees must survive the arm's-length test. A GP charging their own company 10% of rents when market rate is 6–7% erodes LP returns. Fiduciary duty requires market-rate pricing or explicit LP consent — examine every line in the PPM where affiliates receive compensation.
The two-year 1031 clock starts at closing, not identification. Both parties must hold for two full years from closing day. There's a statutory exception if the related party dies, but most life events don't qualify.
Ask an Investor
The Takeaway
A related-party transaction isn't automatically a problem — families sell to each other, LLCs buy from members, and syndicators pay affiliates every day. What makes it manageable is knowing the hard lines before signing: Section 267 disallows losses, 1031 exchanges carry a two-year leash, lenders cap financing at appraised value, and syndication fiduciaries need LP sign-off. Plan around these rules before the contract is signed — they don't bend after the fact.