At-Risk Rules

The at-risk rules limit the loss a taxpayer may deduct from an activity to the amount that taxpayer actually stands to lose in it. In the case of an individual, or a C corporation meeting the stock ownership requirement of section 542(a)(2), engaged in an activity to which the section applies, any loss from that activity for the taxable year is allowed only to the extent of the aggregate amount with respect to which the taxpayer is at risk for that activity at the close of the taxable year (26 U.S.C. 465(a)(1)).

Nothing is lost permanently. Any loss from an activity to which the section applies that is not allowed under it for the taxable year is treated as a deduction allocable to that activity in the first succeeding taxable year (26 U.S.C. 465(a)(2)). The rule is a timing rule with a sting in it, and the sting is the recapture provision at the end.

Who the Rules Reach

The statute names two taxpayers: an individual, and a C corporation with respect to which the stock ownership requirement of paragraph (2) of section 542(a) is met (26 U.S.C. 465(a)(1)).

The IRS states the population more broadly. The at-risk limits apply to individuals, including partners and S corporation shareholders, estates, trusts, and certain closely held C corporations (IRS, Publication 925 (2025)). The publication reaches estates and trusts; the subsection above names an individual and a C corporation and stops there (26 U.S.C. 465(a)(1)).

For the at-risk rules, a C corporation is a closely held corporation if at any time during the last half of the tax year, more than 50% in value of its outstanding stock is owned, directly or indirectly, by or for five or fewer individuals (IRS, Publication 925 (2025)).

What a Loss Means Here

The word is defined, and the definition is wider than a cash shortfall. A loss is the excess of allowable deductions from the activity for the year, including depreciation or amortization allowed or allowable and disregarding the at-risk limits, over income received or accrued from the activity during the year, and income does not include income from the recapture of previous losses (IRS, Publication 925 (2025)). The phrase “allowed or allowable” is the one that catches people: depreciation the client did not claim still counts against them.

What Counts as At Risk

A taxpayer is considered at risk for an activity with respect to amounts including the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and amounts borrowed with respect to that activity as determined under the next paragraph (26 U.S.C. 465(b)(1)). The word “including” is doing work there; the list is not written as an exhaustive one.

Borrowed money splits two ways. A taxpayer is at risk for amounts borrowed for use in an activity to the extent that he is personally liable for the repayment of those amounts, or has pledged property, other than property used in that activity, as security for the borrowed amount, to the extent of the net fair market value of the taxpayer’s interest in that property (26 U.S.C. 465(b)(2)). A sentence closes that paragraph and it closes a loop: no property shall be taken into account as security if that property is directly or indirectly financed by indebtedness which is secured by property described in paragraph (1) (26 U.S.C. 465(b)(2)).

Three further rules pull amounts back out of the total.

Money borrowed from inside the deal. Except to the extent provided in regulations, and for purposes of the borrowed-amounts limb of paragraph (1), amounts borrowed are not considered to be at risk with respect to an activity if they are borrowed from any person who has an interest in that activity, or from a related person to a person other than the taxpayer having such an interest (26 U.S.C. 465(b)(3)(A)). Two interests are carved out of that: an interest as a creditor in the activity, and, in the case of amounts borrowed by a corporation from a shareholder, an interest as a shareholder (26 U.S.C. 465(b)(3)(B)). Related is defined by cross-reference, and for purposes of that subsection: a person is related to any person who bears a relationship specified in section 267(b) or section 707(b)(1), or who is engaged with them in trades or business under common control within the meaning of subsections (a) and (b) of section 52, and in applying section 267(b) or 707(b)(1) here, “10 percent” is substituted for “50 percent” (26 U.S.C. 465(b)(3)(C)). That substitution widens the net considerably.

Money that cannot actually be lost. Notwithstanding any other provision of the section, a taxpayer is not considered at risk with respect to amounts protected against loss through nonrecourse financing, guarantees, stop loss agreements, or other similar arrangements (26 U.S.C. 465(b)(4)). The opening words matter, because that paragraph overrides the rest of the subsection rather than sitting alongside it. What a nonrecourse loan is, and the one real property exception at section 465(b)(6) that puts qualified nonrecourse financing back into the at-risk amount, are set out in non-recourse loan.

Losses already taken. Where the taxpayer has a loss from an activity in any taxable year, the amount at risk in subsequent taxable years for that activity is reduced by that portion of the loss which, after the application of the limitation, is allowable as a deduction (26 U.S.C. 465(b)(5)). This is the paragraph that drives the amount toward zero, and then the recapture rule waits below it.

Which Activities Are Covered

The section names five activities carried on as a trade or business or for the production of income: holding, producing or distributing motion picture films or video tapes; farming as defined in section 464(e); leasing any section 1245 property as defined in section 1245(a)(3); exploring for or exploiting oil and gas resources; and exploring for or exploiting geothermal deposits as defined in section 613(e)(2) (26 U.S.C. 465(c)(1)).

Reading only that list is the common mistake, because a later paragraph extends the section to each activity engaged in by the taxpayer in carrying on a trade or business or for the production of income which is not described in that list (26 U.S.C. 465(c)(3)(A)). The five named activities are not the scope. They are the activities that get their own separation rule.

Separate activities. Except as provided in the aggregation subparagraph below, a taxpayer’s activity with respect to each film or video tape, each section 1245 property which is leased or held for leasing, each farm, each oil and gas property as defined under section 614, and each geothermal property as defined under section 614, is treated as a separate activity (26 U.S.C. 465(c)(2)(A)). Separate activities mean separate at-risk computations, and a loss in one cannot be sheltered by a positive amount in another.

Aggregation. Except as provided in the regulations subparagraph that follows it, activities in the extended category which constitute a trade or business are treated as one activity if the taxpayer actively participates in the management of that trade or business, or if the trade or business is carried on by a partnership or an S corporation and 65 percent or more of the losses for the taxable year is allocable to persons who actively participate in the management of the trade or business (26 U.S.C. 465(c)(3)(B)).

One dated exception. The at-risk rules do not apply to the holding of real property placed in service before 1987, nor to the holding of an interest acquired before 1987 in a pass-through entity engaged in holding real property placed in service before 1987, and that exception does not apply to holding mineral property (IRS, Publication 925 (2025)). Both date qualifiers and the mineral carve-out are part of the rule, not decoration on it.

Where the At-Risk Test Sits in the Order

Order matters, because each limitation runs on the number the previous one produced. The at-risk rules must be applied before the passive activity rules (IRS, Publication 925 (2025)).

For an owner of a pass-through, the publication sets the whole sequence out: the adjusted basis of the partner’s partnership interest, or of the shareholder’s stock plus any loans the shareholder makes to the corporation, then the at-risk rules, then the passive activity rules, then the excess business loss limitation under section 461 (IRS, Publication 925 (2025)). Basis and at-risk amount are different totals for the same owner and they are computed from different inputs, which is why a K-1 can support a deduction on one test and fail the next. What the third test asks is set out in passive activity.

Recapture When the Amount Goes Below Zero

This is the part that turns a timing rule into a charge. If zero exceeds the amount for which the taxpayer is at risk in any activity at the close of any taxable year, the taxpayer includes in gross income for that year, as income from that activity, an amount equal to that excess, and an amount equal to the amount so included is treated as a deduction allocable to that activity for the first succeeding taxable year (26 U.S.C. 465(e)(1)).

There is a ceiling on it. The excess may not exceed the aggregate amount of the reductions required by subsection (b)(5) with respect to the activity by reason of losses for all prior taxable years beginning after December 31, 1978, reduced by the amounts previously included in gross income with respect to that activity under the recapture subsection (26 U.S.C. 465(e)(2)).

The IRS states the same ceiling as a comparison, that the amount added to income is the lesser of the negative at-risk amount treated as a positive amount, or the total amount of losses deducted in previous tax years beginning after 1978 minus any amounts previously added to income from that activity under the recapture rule (IRS, Publication 925 (2025)). One instruction goes with it: do not use the recapture income to reduce any net loss from the activity for the tax year, and instead treat the recaptured amount as a deduction for the activity in the next tax year (IRS, Publication 925 (2025)).

The Form

Form 6198 is used to figure how much loss from an activity can be deducted, and it is filed with the return where the taxpayer has a loss from any part of an activity covered by the at-risk rules and is not at risk for some of the investment in that activity (IRS, Publication 925 (2025)). Both conditions have to hold. A second filing trigger applies to a taxpayer engaged in an activity in the catch-all category who has borrowed amounts of the kind excluded under the certain-borrowed-amounts rule (IRS, Publication 925 (2025)).

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put a block of its own partnership and pass-through work through a trial task before a client file depends on it.