At-Risk Rule
In the past, partners or members of a partnership could deduct losses up to the full amount of their outside tax basis. Recall that tax basis includes both recourse and non-recourse liabilities. That means that taxpayers could claim loss deductions up to the amount of their tax basis, which included liabilities for which they had no risk of loss. A 1976 tax reform corrected this oversight with the at-risk rule.
The at-risk rule created a new calculation, at-risk basis, for the purpose of limiting the deductibility of losses. At-risk basis is distinguished from tax basis in three ways. It does not include:
• non-recourse liabilities
• recourse liabilities, unless the partner is the lender and payer of last resort. In other words, the partner is personally liable for the debt.
• qualified non-recourse financing. Qualified non-recourse financing is money borrowed for holding real estate where no person is personally liable for repayment. Instead, the loan is borrowed or guaranteed by a federal, state, or local government or is borrowed from a “qualified” person, a person such as a bank that is in the business of lending money.
This makes at-risk basis different from tax basis for both partnerships and S corporations, whose stock basis does not include debt of any kind.
Under the at-risk rule, income and deductions are calculated separately. If at-risk basis exceeds losses, all losses are tax deductible. If the partner’s share of losses exceed at-risk basis, deductions will only be allowed to the extent of at-risk basis.
Unlike tax basis, at-risk basis can go negative. Losses in excess of contributions are not tax deductible, but the negative amounts (negative at-risk basis) may be carried over into succeeding tax years until the partner leaves the partnership.
Example: You own a 10% interest in Dement, LP, and your tax basis is $20,000. Of this $20,000, $5,000 represents your capital contribution and $15,000 your shar