At-Risk Rules: Definition and How They Work

The at-risk rules under IRC §465 limit the deductible losses a taxpayer may claim from a business, rental, or investment activity to the amount the taxpayer has economically at risk in that activity. "At risk" means the amount the taxpayer could actually lose — cash invested, the adjusted basis of property contributed, and borrowed funds for which the taxpayer is personally liable or has pledged property not used in the activity as security. Losses that exceed the at-risk amount are not permanently disallowed; they are suspended and carried forward to future tax years when the taxpayer's at-risk amount increases sufficiently to absorb them. Congress enacted the at-risk rules in 1976 to curb tax shelter arrangements in which investors claimed large paper losses while bearing little or no real economic exposure to the investment.

What Is Included in the At-Risk Amount

A taxpayer's at-risk amount for an activity starts at zero and increases or decreases as follows:

Increases the at-risk amount:

  • Cash contributions to the activity
  • Adjusted basis of property contributed to the activity
  • Borrowed amounts for which the taxpayer is personally liable (full recourse debt)
  • Amounts borrowed and secured by property not used in the activity (qualified nonrecourse financing on real estate — see below)
  • The taxpayer's pro-rata share of any partnership or S corporation income allocated to the activity

Decreases the at-risk amount:

  • Losses deducted in prior years
  • Cash and property withdrawn from the activity
  • Decreases in the taxpayer's liabilities that were counted in the at-risk amount

Nonrecourse Debt and the Real Estate Exception

The original rule excluded all nonrecourse debt (borrowings for which the taxpayer has no personal liability) from the at-risk amount — lenders absorb the loss in a default, so the taxpayer is not truly at risk. Congress created a narrow exception for real estate: qualified nonrecourse financing on real property may be included in the at-risk amount even though it is nonrecourse. To qualify, the financing must be:

  1. Borrowed from a qualified person (a bank, savings institution, or other person actively and regularly engaged in lending) or a government entity
  2. Not from a related party (unless the terms are commercially reasonable)
  3. Secured by the real property used in the activity

This exception makes real estate investment much more practical under the at-risk rules — a limited partner who contributes $50,000 to a real estate partnership and receives an allocable share of a $500,000 nonrecourse bank mortgage can include that mortgage share in the at-risk amount, allowing the losses from depreciation and operating expenses to be deductible up to the combined amount.

The At-Risk Rules vs. Passive Activity Loss Rules

The at-risk rules and the passive activity loss (PAL) rules are two separate, sequentially applied loss limitation systems. A loss must clear both hurdles before it is deductible:

  1. Step 1 — At-risk test: Is the loss within the taxpayer's at-risk amount? If not, the excess is suspended as an at-risk carryforward.
  2. Step 2 — Passive activity test: Even if the loss clears the at-risk test, is the activity passive for this taxpayer? If so, the loss can only offset passive income from other activities.

A taxpayer who passes the at-risk test but fails the passive activity test ends up with a passive activity loss (PAL) carryforward — a different basket — rather than an at-risk carryforward. Both systems track suspended losses separately. See Passive Activity Loss Rules for the mechanics of the PAL limitation, which must be applied after the at-risk computation.

Recapture of Prior Losses

If a taxpayer's at-risk amount drops below zero — which can occur when distributions reduce the at-risk amount below the cumulative losses already deducted — the excess must be recaptured as ordinary income under IRC §465(e). This is different from suspended losses: previously deducted losses become taxable in the year the at-risk amount goes negative. This recapture rule is particularly relevant when a partnership or S corporation distributes cash to partners or shareholders after a period of operating losses, and when debt refinancing reduces a taxpayer's share of qualifying nonrecourse debt.

Related Terms

  • Passive Activity Loss Rules — the second loss limitation layer applied after the at-risk test; passive losses must be tracked separately from at-risk carryforwards
  • S-Corp Shareholder Basis — S corporation shareholders face a parallel limitation based on stock and debt basis before the at-risk rules even apply, creating three sequential hurdles for S corp losses
  • Opportunity Zone Tax Incentives — QOF investments are subject to the at-risk rules; the qualified nonrecourse financing exception applies to real property within a QOF
  • IRC §465 — the statutory authority; the IRS activity-by-activity aggregation rules under Reg. §1.465-1T govern how multi-activity taxpayers compute separate at-risk amounts
  • Form 6198 — IRS form used to compute and track the at-risk limitation and suspended at-risk losses; filed for any year in which losses from an at-risk activity exceed the at-risk amount

How CPAs Use the At-Risk Rules in Practice

At-risk analysis most commonly arises in partnerships, S corporations, and real estate investments where losses are passed through to individual investors. The sequential interaction with S corporation basis rules and passive activity rules creates a three-layer loss analysis: (1) basis, (2) at-risk, (3) passive. For S corporation shareholders, the at-risk amount often tracks stock and debt basis closely but diverges when a shareholder guarantees entity-level debt — a guarantee increases basis only if the guarantee is treated as a back-to-back loan, but it does not automatically increase the at-risk amount.

The nonrecourse debt exception for qualified real estate financing requires the lender to be a qualified person. Related-party financing at favorable terms frequently fails this test, making it critical to review loan documentation before projecting the deductibility of real estate partnership losses. When a client asks why losses from a real estate investment are suspended even though they have equity, the answer usually lies in either the nonrecourse debt qualification rules or a drop in the at-risk amount from prior distributions.