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Taxpayers that invest in a trade or business or an activity for the production of income can only deduct losses from the activity or business if the taxpayer is at risk for the investment. A taxpayer is at risk for the amount of cash and the basis of property contributed to the activity. Taxpayers are also at risk for amounts borrowed if the taxpayer is personally liable to pay the liability, or if the taxpayer has pledged property as security for the loan (other than property already used in the business).
A taxpayer is not at risk for a nonrecourse loan, since there is no personal liability. However, amounts at risk include “qualified nonrecourse financing” used in connection with the holding of real estate. A taxpayer also is not at risk for contributions that are protected against loss by a guarantee, stop loss arrangement, or other similar arrangement. For certain activities, such as farming, oil and gas exploration, motion pictures and the leasing of Code Sec. 1245 property, a taxpayer is not at risk for amounts borrowed from related persons or from persons who have an interest in the activity (other than as a creditor).
The at-risk rules apply to all trade or business activities and to activities for the production of income. The rules apply to individuals, partners, S-corporation shareholders, estates, trusts and certain closely held corporations. The at-risk rules generally do not apply to widely held C- corporations, whether public or private. There also is an exception for equipment leasing activities of closely held corporations.
The taxpayer’s amount at-risk limits the allowable loss from the activity. The loss subject to the at-risk limitation is the excess of allowable deductions over the income received from the activity for that year. Under proposed regulations under Code Sec. 465, losses that are allowed as deductions for the tax year reduce the taxpayer’s at-risk amount for the activity for the succeeding year. Losses that are denied under the at-risk rules can be carried over to subsequent years and deducted against amounts at risk in the subsequent years.
The amount at risk must be adjusted each year. At the close of the tax year, the following procedures are used to determine the amount at risk:
If you need help determining if the at-risk rule applies to your activities, contact Doeren Mayhew tax advisors in Michigan, Houston and Ft. Lauderdale. They can help.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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