A non-recourse loan is a secured loan on which the lender’s remedy after default is limited to the pledged collateral, with no claim on the borrower’s other assets or income. If the collateral is sold for less than the balance owed, the borrower is not personally liable for the deficiency. The Seventh Circuit in Racine v. Commissioner described such a debt as an arrangement in which the lender agrees to look exclusively to the collateral, and never to dun the borrower for a deficiency if a sale of the collateral fetches less than the balance (Cornell Law School Legal Information Institute, Wex: nonrecourse).
Federal tax authorities spell it as a single word, nonrecourse, and that spelling carries the defined terms a firm meets on a return: nonrecourse liability, nonrecourse debt, and qualified nonrecourse financing. On a return the term is residual rather than collateral-based: debt for which the taxpayer is personally liable is recourse debt, and all other debt is nonrecourse debt (IRS Publication 4681, for use in preparing 2025 returns).
What Fixes the Label
The collateral does not fix the label, because a recourse loan can be secured too (IRS, Link and Learn Taxes, Recourse vs. Nonrecourse Debt). Courts settle the question by reading the language of the debt instrument (Cornell Law School Legal Information Institute, Wex: nonrecourse), and the general recourse and nonrecourse split in the tax code is in recourse.
Two things qualify that reading. The first is that the answer can turn on where the borrower sits, because whether a debt is recourse or nonrecourse may vary from state to state, depending on state law (IRS, Link and Learn Taxes, Recourse vs. Nonrecourse Debt).
The second is that the lender states its own answer on the information return. Where a lender cancels a debt and issues Form 1099-C, the lender indicates on the form whether the borrower was personally liable for repayment of the debt (IRS, Link and Learn Taxes, Recourse vs. Nonrecourse Debt). That indicator is where a file starts rather than where it ends, because the answer comes from the instrument read under the governing state law.
Qualified Nonrecourse Financing and the At-Risk Rules
The label earns its keep in the at-risk rules, which decide how much of a loss from an activity a taxpayer may deduct. A taxpayer is at risk for borrowed amounts to the extent of being personally liable for repayment, or of having pledged property other than property used in the activity, to the extent of the net fair market value of the taxpayer’s interest in that property, and is not considered at risk for amounts protected against loss through nonrecourse financing, guarantees, stop loss agreements or other similar arrangements (IRC 465(b)(2) and 465(b)(4)).
An ordinary nonrecourse loan therefore does not add to the amount at risk, and a loss greater than the at-risk amount is suspended and treated as a deduction for the activity in the following year (IRS Publication 925, for use in preparing 2025 returns).
Real property is the exception, and it is written into the statute. For an activity of holding real property, a taxpayer is considered at risk for the taxpayer’s share of any qualified nonrecourse financing which is secured by real property used in that activity (IRC 465(b)(6)(A)).
What Counts as Qualified Nonrecourse Financing
Qualified nonrecourse financing is financing for which no one is personally liable for repayment and that is borrowed in connection with the activity of holding real property, secured by real property used in the activity, not convertible from a debt obligation to an ownership interest, and either borrowed from a qualified person or loaned or guaranteed by a federal, state or local government (IRS Publication 925).
A qualified person is one who actively and regularly engages in the business of lending money, and the most common example is a bank. A person related to the taxpayer is not one, unless the financing is commercially reasonable and on the same terms as loans involving unrelated persons (IRS Publication 925).
One limit keeps the exception narrower than it reads. The activity of holding real property does not include the holding of mineral property (IRC 465(b)(6)(E)(ii)).
A Partner’s Share of Qualified Nonrecourse Financing
For a partnership, a partner’s share of any qualified nonrecourse financing is determined on the basis of the partner’s share of the partnership liabilities incurred in connection with that financing, within the meaning of section 752 (IRC 465(b)(6)(C)).
Basis and at-risk amount are two different totals for the same partner. A Schedule K-1 shows the partner’s share of nonrecourse liabilities, of partnership-level qualified nonrecourse financing and of other recourse liabilities, and the total of the three is used for figuring the adjusted basis of the partnership interest, the partner’s investment in the partnership measured for tax purposes, while generally only the qualified nonrecourse financing and recourse amounts may be used to figure the amount at risk (2025 Partner’s Instructions for Schedule K-1 (Form 1065)). Where each one is reported is set out in recourse.
How a Partnership Splits a Nonrecourse Liability
A partner’s share of the nonrecourse liabilities of a partnership equals the sum of three amounts (26 CFR 1.752-3(a)). None of the three is the constructive-liquidation economic-risk-of-loss test, which is the separate question of whether a liability is recourse at all and is covered in recourse.
The first amount is the partner’s share of partnership minimum gain, determined in accordance with the rules of section 704(b) and the regulations under it (26 CFR 1.752-3(a)(1)). Minimum gain on an item of partnership property subject to a nonrecourse liability equals the amount of gain that would be recognized if the partnership disposed of that property in full satisfaction of the nonrecourse liability and for no other consideration (26 CFR 1.752-3(c), Example 1).
The second amount is any taxable gain that would be allocated to the partner under section 704(c), or in the same manner as section 704(c) in connection with a revaluation of partnership property, if the partnership disposed of all partnership property subject to nonrecourse liabilities in a taxable transaction, in full satisfaction of those liabilities and for no other consideration (26 CFR 1.752-3(a)(2)).
The third amount is the partner’s share of the excess nonrecourse liabilities, meaning those not allocated by the first two, determined in accordance with the partner’s share of partnership profits, which is itself settled by taking into account all facts and circumstances relating to the economic arrangement of the partners (26 CFR 1.752-3(a)(3)).
That third tier is the one a partnership agreement can steer, and the method does not have to be the same one each year (26 CFR 1.752-3(a)(3)).
The section 704(b) rules the first tier answers to, and the built-in gain that rides on property a partner contributes under section 704(c), are set out in equity ownership.
The balance sheet side of the same borrowing, where a partnership return carries all nonrecourse loans on a line of its own, is in loan payable.
What Happens When the Property Goes
The amount realized from a sale or other disposition of property includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition, and a sale or other disposition of property that secures a nonrecourse liability discharges the transferor from that liability (Treasury Regulation 1.1001-2(a)(1) and (a)(4)(i)).
The value of the collateral does not soften that. The fair market value of the security at the time of the sale or disposition is not relevant in working out the amount of liabilities from which the taxpayer is discharged, so the fact that the property is worth less than the liabilities it secures does not stop the full amount of those liabilities being treated as money received (Treasury Regulation 1.1001-2(b)).
The recourse side goes the other way, and the difference is cancellation-of-debt income. Where property subject to a recourse debt in excess of its fair market value is foreclosed on, the gain or loss is measured by the difference between that fair market value and the adjusted basis, and forgiveness of the debt above the fair market value may be ordinary cancellation-of-debt income. Where the debt is nonrecourse, the foreclosure does not produce cancellation-of-debt income at all, because the entire amount of the nonrecourse debt is treated as an amount realized on the disposition (IRS Publication 4681, for use in preparing 2025 returns).
Abandonment and a workout split the same way. Abandoning property that secures a nonrecourse debt may produce a gain or a loss but produces no cancellation-of-debt income, while abandoning property that secures a recourse debt which is then canceled produces ordinary income equal to the canceled debt. And where a lender reduces the principal balance of a nonrecourse loan and the borrower did not keep the collateral, there is no cancellation-of-debt income (IRS Publication 4681).
When an abandonment counts as a disposition for depreciation purposes is a separate question, covered in disposition.
A Worked Example
Say a partnership holds a building financed with a nonrecourse mortgage, the lender forecloses, and the building is worth less than the balance owed.
Adjusted basis of the building 600,000
Nonrecourse mortgage balance at foreclosure 850,000
Fair market value of the building 700,000
Amount realized (the whole nonrecourse balance) 850,000
less adjusted basis 600,000
Gain realized 250,000
Ordinary income from cancellation of debt 0The gain is measured against the whole balance rather than against the value of the building, so the partnership reports a gain in a year it received no cash. Had the same mortgage been recourse, the gain would have been measured against the fair market value, and the shortfall between the balance and that value could have been ordinary cancellation-of-debt income instead.
Carve-Outs and Springing Recourse
A loan can be drafted as nonrecourse and still name events that make a guarantor personally liable. In commercial real estate finance a guarantee is commonly conditioned on nonrecourse carve-out events, sometimes called bad boy guarantees: taking subordinate financing or transferring the secured property without the lender’s consent, bankruptcy steps taken or solicited by the borrower or a person in control of it, consenting to a receiver or custodian of assets, and assigning assets for the benefit of creditors or admitting insolvency in writing (IRS Office of Chief Counsel, Memorandum AM2016-001). A guarantee like that creates recourse that springs into existence only on the named event.
The Office of Chief Counsel concluded that such a guarantee does not cause the obligation to fail to qualify as a nonrecourse liability of the partnership under section 752, or as qualified nonrecourse financing for purposes of section 465(b)(6), until one of those events actually occurs and causes the guarantor to become personally liable for the partnership debt under local law (IRS Office of Chief Counsel, Memorandum AM2016-001).
The reasoning sits in the liability regulations. A payment obligation is disregarded if, taking into account all the facts and circumstances, the obligation is subject to contingencies that make it unlikely that the obligation will ever be discharged, and an obligation that would arise at a future time after the occurrence of an event that is not determinable with reasonable certainty is ignored until the event occurs (26 CFR 1.752-2(b)(4)).
That memorandum says on its face that it may not be used or cited as precedent, so it shows the Service’s position rather than authority a firm can rely on. The practical point for a file is timing: a carve-out sitting unused in the documents leaves the nonrecourse label alone, and the label changes when the event happens, not before.
Common Questions About Non-Recourse Loans
That is a credit question, and no tax authority answers it. What the tax rules do fix is who the lender can be if the borrower wants the loan to count as qualified nonrecourse financing, which is why a nonrecourse note taken back by the seller of the property can be genuinely nonrecourse and still leave the buyer with no at-risk amount (IRS Publication 925).
The rules point at real estate. The at-risk relief for qualified nonrecourse financing is written only for an activity of holding real property (IRC 465(b)(6)(A)), and the Office of Chief Counsel has described the inclusion of nonrecourse carve-out provisions in loan agreements as a fairly common practice throughout the commercial real estate finance industry (IRS Office of Chief Counsel, Memorandum AM2016-001).
Three risks show up on a return. A foreclosure can produce a taxable gain larger than any cash received, because the full balance is the amount realized. Outside the qualified nonrecourse financing exception, the loan does not add to the amount at risk, so losses sit suspended (IRS Publication 925, for use in preparing 2025 returns). And a triggered carve-out can make a guarantor personally liable, which moves the answer under both section 752 and section 465 (IRS Office of Chief Counsel, Memorandum AM2016-001).
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 basis and at-risk work through a trial task before any of it reaches a client file.
