IRC Section 465 at-risk rules limit the losses that a taxpayer can claim from an activity to the amount of capital the taxpayer has genuinely "at risk" in the activity. Unlike passive loss limitations (which are based on material participation), at-risk limitations apply regardless of how much time the taxpayer spends in the activity. When combined with passive loss rules (IRC Section 469) and basis limitations (IRC Section 704), at-risk rules can suspend losses indefinitely, even when the business owner is materially participating and has documented 750+ hours of activity management.
What is "At-Risk" Basis? IRC Section 465(b)
Under IRC Section 465(b), a taxpayer's at-risk amount in an activity equals:
- Cash contributed to the activity
- Adjusted basis of other property contributed
- Borrowed funds for which the taxpayer is personally liable or which are secured by non-activity property
- MINUS: Cash distributions and other property withdrawals
Importantly, IRC Section 465(b)(3) excludes from at-risk basis loans for which the taxpayer is not personally liable ("nonrecourse loans").
Qualified Nonrecourse Financing Exception (IRC Section 465(c)(3))
There is one exception: certain "qualified nonrecourse loans" (primarily real estate mortgages) are included in at-risk basis under IRC Section 465(c)(3), even though they are nonrecourse to the borrower.
A qualified nonrecourse loan must:
- Be secured by real property in the activity
- Be borrowed in connection with the acquisition, construction, or improvement of the real property
- Be from a "qualified lender" (financial institutions, not the seller or promoter)
- Not be guaranteed by the borrower (unless the guarantee is full recourse, in which case it loses nonrecourse status anyway)
This exception is critical for real estate investors: a rental property purchased with 80% financing from a bank (standard nonrecourse mortgage) is included in at-risk basis as a qualified nonrecourse loan.
Non-Qualified Nonrecourse Financing and Loss Suspension
If a real estate investor finances an investment property with non-qualified nonrecourse debt (e.g., a seller-financed mortgage where the seller takes a second deed of trust, or financing from a related party not at arm's length), the financed portion is NOT included in at-risk basis. Any losses are suspended up to the at-risk basis, regardless of participation or passive loss treatment.
Example: A property is purchased for $1 million. Buyer contributes $200,000 cash and obtains a $300,000 bank mortgage (qualified nonrecourse = included in at-risk basis = $500,000 total at-risk) and a $500,000 seller-financed note (non-qualified nonrecourse = NOT included in at-risk basis). At-risk basis = $500,000. If the property generates $400,000 in losses, only $0 losses are deductible (losses in excess of at-risk basis are suspended). Wait, that math doesn't work. Let me recalculate: At-risk basis = $200,000 (cash) + $300,000 (qualified bank mortgage) = $500,000. Losses allowed = up to $500,000. If losses are $400,000, all are deductible (within at-risk amount).
The Interaction with Partnership Basis Limitations (IRC Section 704(d))
Partnership losses are subject to three separate limitations:
- Passive activity loss rules (IRC Section 469) suspend losses if not actively participated
- At-risk limitations (IRC Section 465) suspend losses in excess of at-risk basis
- Outside basis limitations (IRC Section 704(d)) limit losses to the partner's outside basis
A partner can have sufficient passive loss deduction (under Section 469) and sufficient at-risk basis (under Section 465), but still be unable to deduct losses if the partner's outside basis is insufficient.
Example: Partner A has $150,000 outside basis in a partnership but contributes $200,000 in a capital call (increasing outside basis to $350,000). The partnership generates a $300,000 loss. Passive loss rules allow deduction (assume material participation). At-risk rules allow deduction (assume sufficient at-risk basis). However, outside basis limitation (IRC Section 704(d)) limits deduction to $350,000 (the partner's outside basis), so the $300,000 loss is allowed. After the loss deduction, outside basis is reduced to $50,000.
Loss Recapture Upon Refinancing (IRC Section 465(d))
A critical at-risk rule: if an at-risk loss is suspended and the activity is later refinanced with nonrecourse debt, the suspended loss is recaptured (becomes a recognized loss/gain) in the year of refinancing.
This creates a significant planning issue: a business owner who has suspended losses due to at-risk limitations and later refinances the property (by converting recourse financing to nonrecourse, or by taking additional nonrecourse debt) triggers recapture of the suspended losses as recognized gains.
At-Risk Tracking and Multi-Year Basis Management
At-risk basis must be tracked independently from tax basis and outside basis. The three bases can diverge significantly:
- Tax basis (IRC Section 1011) reflects actual cost and adjustments for depreciation
- At-risk basis (IRC Section 465) reflects actual capital and qualified nonrecourse debt
- Outside basis (IRC Section 704(c)) reflects partnership book equity
An investor can have $500,000 in tax basis (with depreciation deductions), $300,000 in at-risk basis (due to nonqualified nonrecourse financing), and $200,000 in outside basis (due to prior year losses). Different limitations apply to each basis type, creating complex loss deduction calculations.
Key Takeaways for Business Owners
- At-risk limitations suspend losses in excess of at-risk basis, regardless of material participation or passive loss status
- At-risk basis includes cash contributed, property contributed, and recourse loans
- Qualified nonrecourse financing (bank mortgages on real property) is included in at-risk basis
- Non-qualified nonrecourse financing (seller financing, related-party loans) is excluded from at-risk basis
- Suspended at-risk losses are recaptured as recognized losses upon refinancing with nonrecourse debt
- At-risk basis must be tracked separately from tax basis and outside basis
- Three loss limitations can apply simultaneously: passive loss (Section 469), at-risk (Section 465), and basis (Section 704(d))
The Bottom Line
At-risk limitations can suspend valuable tax losses indefinitely if not properly managed. Business owners with leveraged investments should verify at-risk basis status and avoid non-qualified nonrecourse financing that would create at-risk suspension. The combination of passive loss rules, at-risk limitations, and basis limitations can eliminate loss deductions entirely if not coordinated strategically.