10.18 What Is At Risk?

The following amounts are considered at risk in determining your tax position in a business or investment:

Personal liability alone does not assure that the borrowed funds are considered at risk. The lender generally must have no interest in the venture other than as a creditor and must not be related to a person (other than the borrower) with an interest in the activity other than that of a creditor. Under final IRS regulations, a lender or person related to the lender is considered to have an interest other than that of a creditor only if the person has a capital interest in the activity or an interest in the net profits of the activity. However, even if the lender has such an interest, a loan after May 3, 2004, for which you are personally liable is treated as at risk if: (1) the loan is secured by real estate used in the activity and (2) the loan, were it nonrecourse, would be qualified nonrecourse financing, as discussed below.

At-risk basis is figured as of the end of the year. Any loss allowed for a year reduces the at-risk amount as of the start of the next year. Therefore, if a loss exceeds your at-risk investment, the excess loss will not be deductible in later years unless you increase your at-risk investment; see the Example below and 10.21.

Qualified nonrecourse financing for real estate considered at risk.

Generally, you are not considered at risk for nonrecourse financing, that is, loans for which you are not personally liable, unless the loan is secured by property not used in the activity. However, you are considered to be at risk for qualified nonrecourse financing. This is financing from an unrelated commercial lender or government agency for which no one is personally liable and which is secured by real estate used in the activity. The debt obligation must not be convertible to an ownership interest. In determining whether the financing is secured only by real property used in the activity, you can ignore security that is property valued at less than 10% of the total value of all property securing the financing, as well as property that is incidental to the activity of holding real property. Loans from the seller or promoter do not qualify. Third-party nonrecourse debt from a related lender, other than the seller or promoter, may also be treated as at risk, providing the terms of the loan are commercially reasonable and on substantially the same terms as loans involving unrelated persons.

Pledges of other property.

If you pledge personally owned real estate used outside the activity to secure a nonrecourse debt and invest the proceeds in an at-risk activity, the proceeds may be considered part of your at-risk investment. The proceeds included in basis are limited by the fair market value of the property used as collateral (determined as of the date the property is pledged as security) less any prior (or superior) claims to which the collateral is subject.

Partners.

A partner is treated as at-risk to the extent that basis in the partnership is increased by the share of partnership income. That partnership income is then used to reduce the partnership’s nonrecourse indebtedness will have no effect on a partner’s amount at risk. If the partnership makes actual distributions of the income in the taxable year, the amount distributed reduces the partner’s amount at risk. A buy-sell agreement, effective at a partner’s death or retirement, is not considered for at-risk purposes.