The at-risk rules under IRC §465 limit loss deductions from an activity to the amount the taxpayer has economically at risk in that activity. The rules exist to prevent taxpayers from deducting losses that exceed their actual economic exposure - particularly where nonrecourse financing means the lender, not the taxpayer, bears the downside. At-risk is a separate limitation from passive activity - a loss must clear both hurdles before it is deductible, and the ordering matters.
A taxpayer is considered at-risk in an activity to the extent of:
Amounts are not at-risk when: the taxpayer is protected against loss by guarantees, stop-loss agreements, or nonrecourse financing (other than qualified nonrecourse financing); or when the borrowed funds come from a person who has an interest in the activity other than as a creditor.
If the activity fails completely - zero value recovered - how much does the taxpayer actually lose out of pocket? That is the at-risk amount. If a nonrecourse lender provided $1M of financing and the taxpayer put in $100K of equity, the taxpayer loses at most $100K. The $1M nonrecourse debt is the lender's risk, not the taxpayer's. Therefore losses are limited to $100K regardless of how large the paper losses are.
Recourse debt increases the taxpayer's at-risk amount because the taxpayer is personally liable. If the activity's assets do not cover the debt, the lender can pursue the taxpayer's other assets - wages, savings, other property. The taxpayer has real economic exposure equal to the full recourse debt.
Nonrecourse debt generally does not increase at-risk amounts. The lender's only remedy on default is the collateral - the activity's assets. The taxpayer can walk away from the activity, hand over the collateral, and owe nothing more. Since the taxpayer bears no personal risk beyond the collateral, nonrecourse debt does not count as at-risk.
IRC §465(b)(6) provides an important exception: qualified nonrecourse financing used in a real property activity counts as at-risk, even though it is nonrecourse. Qualified nonrecourse financing must be: (a) borrowed from a qualified person (a bank, insurance company, pension fund, or other person in the business of lending money who is not related to the taxpayer or a seller/promoter), (b) secured by real property used in the activity, and (c) not convertible debt and not seller financing from a related party.
The at-risk amount is computed separately for each activity and is adjusted annually. It increases by: income from the activity, additional cash contributions, and net increases in qualified borrowings. It decreases by: losses deducted from the activity, distributions received from the activity, and net decreases in qualified borrowings (repayments or reclassification of recourse to nonrecourse debt).
Losses in excess of the at-risk amount are suspended - not lost permanently. They carry forward indefinitely and become deductible when the at-risk amount increases sufficiently (through additional contributions, income, or qualified borrowings) or when the activity is disposed of in a fully taxable transaction.
If an at-risk amount that was previously positive drops below zero - because of distributions, loss of recourse protection, or debt being converted from recourse to nonrecourse - the taxpayer must recapture previously deducted losses as income. The recapture amount equals the lesser of the prior deducted losses or the amount by which the at-risk balance went negative.
The three major loss limitation rules apply in a specific order: (1) basis limitations (IRC §704(d) for partnerships, §1366 for S-corps), (2) at-risk limitations (IRC §465), (3) passive activity limitations (IRC §469). A loss must survive each limitation in sequence to be deductible.
| Step | Limitation | Governing Code | Effect if Exceeded |
|---|---|---|---|
| 1 | Basis limitation | IRC §704(d) / §1366 | Loss suspended until basis restored by contributions or income |
| 2 | At-risk limitation | IRC §465 | Loss suspended until at-risk amount increases or activity disposed of |
| 3 | Passive activity limitation | IRC §469 | Loss suspended until passive income exists or activity disposed of |
IRC §465 applies to most business and investment activities, with the key exception being C-corporations that are not closely held. For individuals, S-corporation shareholders, and partners in partnerships, at-risk rules apply to: trade or business activities, rental activities, equipment leasing, farming, oil and gas, and most other for-profit activities. Each activity is tracked separately - at-risk in one activity cannot shelter losses from another.