10.17 At-Risk Limits

The at-risk rules prevent investors from claiming losses in excess of their actual tax investment by barring them from including nonrecourse liabilities as part of the tax basis for their interest. Almost all ventures are subject to the at-risk limits. Real estate placed in service after 1986 is subject to the at-risk rules as well, but most real estate nonrecourse financing can qualify for an exception (10.18).

Caution

At-Risk Rules Limit Loss Deductions

The purpose of at-risk rules is to keep you from deducting losses from investments in which you have little cash invested and no personal liability for debts.

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Losses disallowed under the at-risk rules are carried over to the following year (10.21).

Form 6198.

If you have amounts that are not at risk, you must file Form 6198 to figure your deductible loss. A separate form must be filed for each activity. However, if you have an interest in a partnership or S corporation that has more than one investment in any of the following four categories, the IRS currently allows you to aggregate all of the partnership or S corporation activities within each category. For example, all partnership or S corporation films and videotapes may be treated as one activity in determining amounts at risk. The aggregation rules may be changed by the IRS; see the instructions to Form 6198.

Filing Tip

Form 6198

If you have invested an amount for which you are not at risk, such as a nonrecourse loan, you generally must file Form 6198 to figure a deductible loss. However, nonrecourse financing for real estate that secures the loan is treated as an at-risk investment in most cases (10.18).

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In addition to the previous categories, the law treats as a single activity all leased depreciable business equipment (Section 1245 property) that is placed in service during any year by a partnership or S corporation.

Exempt from the at-risk rules are C corporations which meet active business tests and are not in the equipment leasing business or any business involving master sound recording, films, videotapes, or other artistic, literary, or musical property. For details on the active business tests, as well as a special at-risk exception for equipment leasing activities of closely held corporations, see IRS Publication 925.

The at-risk limitation applies only to tax losses produced by expense deductions that are not disallowed by reason of another provision of the law. For example, if a prepaid interest expense is deferred under the prepaid interest limitation (15.14), the interest will not be included in the loss subject to the risk limitation. When the interest accrues and becomes deductible, the expense may be considered within the at-risk provision. Similarly, if a deduction is deferred because of farming syndicate rules, that deduction will enter into the computation of the tax loss subject to the risk limitation only when it becomes deductible under the farming syndicate rules.

Effect of passive loss rules.

Where a loss is also subject to the at-risk rules, you apply the at-risk rules first. If the loss is deductible under the at-risk rules, the passive activity rules then apply. On Form 6198 (at risk), you figure the deductible loss allowed as at risk and then carry the loss over to Form 8582 to determine the passive activity loss.