At-Risk Rules in Taxation

At-Risk Rules

• Deductible losses are limited to the amount the taxpayer is at-risk
• Losses carried forward until the at-risk amount increases
• Previously allowed losses recaptured if the at-risk amount is reduced below zero
• At-risk rules apply separately to each activity
• Deductible losses are limited when losses exceed the amount at risk
• At-risk limitations do not apply if the activity generates income (unless carryover losses exist)
• Previously allowed losses must be recaptured if the at-risk amount is reduced

Increasing At-Risk Amount

• Cash and adjusted basis of property contributed to the activity
• Borrowed funds used in the activity where the taxpayer is personally liable or uses property outside the activity for security
• Borrowed funds used in the activity in qualified nonrecourse financing (real estate)
• Taxpayer's share of the activity's income

Decreasing At-Risk Amount

• Withdrawals from the activity
• Taxpayer's share of the activity's deductible loss
• Taxpayer's share of any debt reductions where the taxpayer is liable or qualified nonrecourse debt reductions

Other At-Risk Rules

• Loans from persons who have an interest in the activity (other than as a creditor), or from a related individual do not increase the at-risk amount
• Loans guaranteed by a taxpayer are generally not included in the at-risk amount as the taxpayer is not personally liable
• The IRS can disregard arrangements designed to avoid the at-risk limitations
• Recourse debt converted to nonrecourse debt is generally not considered at-risk

Qualified Nonrecourse Financing

• Qualified nonrecourse financing is considered at-risk for real estate if the borrowing is for holding real property, the borrowing is from a qualified entity, and the borrowing is not convertible debt

Interest

• Interest is compensation for the use or forbearance of money

Interest Income and Expense

• Interest received by a lender is taxable income
• Interest expense is generally deductible and must be paid on indebtedness
• Prepaid interest is taxable upon receipt
• Prepaid interest expense is generally allocated over the term of the loan
• Points are typically prepaid interest deductible over the loan term, unless for services provided by the lender

Investment Interest

• Investment interest is interest on loans used to purchase investment property (stock, bonds, land)
• The investment interest deduction is limited for non-corporate taxpayers
• Net investment income is investment income less investment expenses

Tracing Debt Proceeds

• There is an ordering rule when debt proceeds from multiple loans are deposited in the same account
• The 15-day rule may be used to treat an expenditure as coming from deposited debt proceeds
• There is an ordering repayment rule when debt is repaid and debt proceeds are allocated to more than one expenditure

Business Interest

• Business interest paid or accrued is limited to the sum of business interest income, 30% of adjusted taxable income, and floor plan financing interest
• The business interest limitation may be carried forward indefinitely
• The limitation does not apply to farming or real property trades if an election is made

Sale-Leaseback

• The transaction must be treated as a sale and leaseback rather than a financing transaction to obtain tax benefits
• If treated as a financing transaction, the seller may not deduct lease payments and the payments will be treated as payments on a loan
• Determining whether a transaction is a sale-leaseback or a financing arrangement can be difficult

This quiz covers the fundamental concepts of at-risk rules in taxation, including limitations on deductible losses and how the at-risk amount can increase or decrease. Test your knowledge on how these rules apply to various activities and the implications for taxpayers. Ideal for students of tax law and accounting.