Legal Definitions - at-risk rules

The at-risk rules are specific tax laws designed to limit the amount of losses a taxpayer can deduct from certain investments or activities. These rules ensure that a taxpayer can only claim losses up to the amount of money they have genuinely put at risk and could actually lose if the investment fails. The primary purpose is to prevent individuals from using artificial or inflated losses, often from investments where they have little actual financial exposure, to reduce their taxable income.

Here are some examples to illustrate the at-risk rules:

• Real Estate Partnership with Non-Recourse Loan:

  Imagine Sarah invests $50,000 cash into a real estate development partnership. The partnership also secures a $200,000 loan for the project, but this loan is "non-recourse," meaning Sarah is not personally responsible for repaying it if the project fails. Under the at-risk rules, Sarah's maximum deductible loss from this partnership is $50,000. Even if the partnership incurs $100,000 in losses, she can only deduct $50,000 because that's the actual amount of her own money she could lose. She is not "at risk" for the non-recourse loan portion, as she bears no personal liability for it.

• Startup Business with Personal Guarantee:

  Consider David, who invests $25,000 directly into a new tech startup. To help the startup secure additional funding, David also personally guarantees a $75,000 bank loan for the company. Because David has personally guaranteed the loan, he is financially responsible for it if the startup defaults. Therefore, his total "at-risk" amount for tax purposes is $100,000 ($25,000 direct investment + $75,000 guaranteed loan). If the startup fails and he has to pay back the loan, he can deduct losses up to this full amount, as he genuinely risked that entire sum.

• Limited Partnership in a Film Production:

  Emily invests $10,000 as a limited partner in a film production company. Her agreement clearly states that her liability is strictly limited to her initial investment. If the film project significantly underperforms and incurs losses far exceeding her initial investment, Emily can only deduct a maximum of $10,000 in losses on her tax return. The at-risk rules prevent her from claiming larger losses, even if the company's total losses are higher, because her personal financial exposure is capped at her original $10,000 contribution; she cannot lose more than that amount.