The at-risk rules limit your ability to deduct losses from your business activities. With these rules in place, the losses you may deduct on your individual tax return are limited to your investment in the company. The most common scenario that might result in a disallowed loss under the at-risk rules is if you invest borrowed money that you are not personally responsible to repay, referred to as nonrecourse debt.
Taxpayers with a loss on Schedule C must indicate on Line 32 whether they have all of their investment at risk. Most taxpayers answer that all of their investments are at risk—unless they have nonrecourse debt.
Key Takeaways
- The vast majority of all Schedule C and rental property owners have all their investment at risk.
- You cannot deduct more than the money you’ve invested in your business that you are at risk of losing.
- Borrowed money that you are not personally liable to repay is not “at-risk” and might limit the amount of loss from business that you can deduct.
Who Is Subject to the At-risk Rules?
You may be subject to the at-risk rules if you have:
- Losses from an activity carried on as a trade business or from a real estate activity.
- Investments not at risk.
Amount at Risk for Schedule C & Rental Activities
You are typically at risk of losing the following amounts:
- Any money or property you invest in your business
- Any amount you borrow and are personally liable for the payment
- Any amount borrowed that is secured by property outside the business activity
How To Calculate Amount at Risk
1. Form 6198
IRS Form 6198 helps you figure out how much you can claim if your business lost money during the tax year. You must complete a separate Form 6198 for each business or activity subject to at-risk rules. Learn how to fill out your Form 6198.
The form is divided into the following four sections:
- Part I – Current Year Profit (Loss) From the Activity, Including Prior Year Nondeductible Amounts. You’ll use this section to determine how much loss you incurred in the present year.
- Part II – Simplified Computation of Amount at Risk. Schedule C and E filers cannot use the simplified computation in Part II and instead must complete Part III.
- Part III – Detailed Computation of Amount at Risk. Here, you’ll determine the amount at risk in your Schedule C business or rental activity.
- Part IV- Deductible Loss. You’ll determine your allowable deduction for the present tax year in this section.
2. Indirect Method
Outside of using Form 6198, another way to calculate your at-risk investment is to start with the total adjusted basis of all assets within the activity and subtract any investment that is not at risk.
Investments Not at Risk in Schedule C & Rental Activities
Let’s look at situations that might generate investments not at risk and therefore limit the deductibility of your losses.
You are not at risk for:
- Amounts that you borrow from a person who you are related to or from a person who has an interest in your business activity
- Guarantees, stop-loss agreements, or any similar arrangements
- Nonrecourse loans, such as seller-financed arrangements, unless the loan is a qualified nonrecourse loan (discussed below)
If any of the situations above apply, you may not claim the losses of that investment.
What Are Qualified Nonrecourse Loans?
Qualified nonrecourse loans are a type of financing that no one is personally liable to repay. These loans must be backed by real property and are treated as amounts at risk. If you have one of these loans, they must also be:
- Borrowed by you to acquire real property
- Secured by real property used in your business activity
- Borrowed from a bank or other financial institution
Let’s look at an example of a qualified nonrecourse loan. Ms. X paid $250,000 for a rental house with $50,000 of cash and got a $200,000 mortgage from a bank. Since the mortgage is secured by the house and the mortgage is provided by a bank, the $200,000 is qualified recourse debt and is included in Ms. X’s at-risk investment.
Frequently Asked Questions (FAQs)
Any loss that isn’t allowed because of the at-risk limits is carried over to future years and can be deducted when there is adequate at-risk investment.
You should file Form 6198 if during the tax year you had any investments not at risk in an activity that incurred a loss. This could be amounts you have invested that were borrowed from a person related to you or amounts that have been invested from a nonrecourse loan.
If you dispose of your businesses and have at-risk losses disallowed from a prior year, those losses can be used to offset any gain in the year of disposition. Any disallowed losses in excess of the final-year gain are lost and cannot be deducted.
Bottom Line
The at-risk limits will determine the amount of losses from business or real estate activities you may deduct if you are not personally at risk of losing a portion of your investment during any tax year. If these rules apply to your business, make sure you are aware of the amount of money or property you have at risk in the activity by the end of the tax year.
