Rental property owners use Form 6198 when a rental activity produces a net loss and some portion of the investment isn’t considered “at risk” under the tax code. The form caps the deductible loss at the amount you could personally lose. In practice, most landlords with a conventional bank mortgage never touch it, because that kind of financing qualifies for a real estate carve-out that treats the debt as at-risk. The form starts to matter when the loss is funded by seller carry-back notes, loans from related parties, or other non-standard debt.
When the Form Is Required
Two conditions have to be present together. Your rental activity has to show a loss for the year, and you have to have amounts in that activity that aren’t at risk.1Internal Revenue Service. Instructions for Form 6198 A rental property producing positive income doesn’t need the form no matter how it’s financed, because there’s no loss to limit. A rental loss funded entirely with cash you invested plus debt you’re personally liable for doesn’t need it either, because your full investment is already at risk.
The at-risk rules under Internal Revenue Code Section 465 apply to individuals and to C corporations where five or fewer individuals own more than half the stock.2Office of the Law Revision Counsel. 26 U.S. Code 465 – Deductions Limited to Amount at Risk If you own a rental through an S corporation or partnership, the entity itself doesn’t file Form 6198. Losses flow to you, and you run the at-risk calculation on your personal return. You need a separate Form 6198 for each rental activity, or group of aggregated properties, that generated a loss.
Why Most Mortgages Don’t Trigger the Form
Real estate gets a special exception that lets you treat certain nonrecourse debt as if you were personally on the hook for it. The IRS calls this “qualified nonrecourse financing,” and it’s the reason the typical landlord with a bank loan never has to think about Form 6198.2Office of the Law Revision Counsel. 26 U.S. Code 465 – Deductions Limited to Amount at Risk
Four conditions have to be satisfied. The loan has to be taken out for the activity of holding real property. It has to come from a person actively and regularly engaged in the business of lending money (a bank, credit union, or similar institution), or from a federal, state, or local government. No person can be personally liable for repayment. And the loan can’t be convertible into an ownership interest in the activity. The financing also has to be secured by the real property used in the activity.3Legal Information Institute. 26 U.S. Code 465(b)(6) – Qualified Nonrecourse Financing
A standard mortgage from a commercial bank on a rental property will almost always meet all four. Trouble shows up with less conventional arrangements.
Financing That Breaks the Exception
Seller financing is the biggest trap. When the person who sold you the property also carried the note, that seller generally isn’t a “qualified person” under the statute. The law specifically excludes the seller of the property from the qualified-lender definition.4Legal Information Institute. 26 U.S. Code 465(b)(6)(D) – Qualified Person Defined If a seller carry-back note is also nonrecourse, it won’t count toward your at-risk amount and your deductible losses could be sharply limited.
Loans from related parties raise the same problem. Financing from a family member or an entity you control generally won’t qualify unless the terms are commercially reasonable and substantially similar to what an unrelated lender would offer.4Legal Information Institute. 26 U.S. Code 465(b)(6)(D) – Qualified Person Defined
Loans with equity conversion features also fail. If the lender can convert the debt into a partnership interest or ownership stake, it’s not qualified nonrecourse financing regardless of who the lender is.
Any of these situations, combined with a rental loss, puts you on Form 6198.
How the At-Risk Amount Is Calculated
Your at-risk amount is the ceiling on deductible losses from a rental activity. It’s built from three components: cash you’ve invested, the adjusted basis of property you’ve contributed, and qualifying debt.
Recourse debt always counts. If you personally guarantee a loan, the lender can pursue your other assets when the property doesn’t cover what you owe, so that money is genuinely at risk. Nonrecourse debt only counts if it satisfies the real estate exception above.
The number moves each year. Additional cash you invest, new qualifying debt, and your share of the activity’s income all push it up. Losses you’ve deducted, cash withdrawals, distributions, and reductions in qualifying debt all pull it down.
S corporation shareholders face an extra restriction. You generally can’t include corporate-level debt in your personal at-risk amount. Only capital you’ve contributed and money you’ve lent directly to the S corporation counts. Identical losses run through a partnership or sole proprietorship are less likely to bump into the at-risk ceiling than losses in an S corporation.
Working Through the Form
Form 6198 has four parts. Parts II and III are alternative ways to reach the same number, so a typical filing means Part I, one of the middle two parts, and Part IV.5Internal Revenue Service. Form 6198 (Rev. November 2025)
Part I pulls in the rental activity’s net result for the year, including any suspended losses carried forward from prior years. Your Schedule E loss feeds this calculation, and the total lands on line 5. If the result is a profit, you stop. There’s no loss to limit.
Part II is a simplified method that works if you already know your adjusted basis in the activity. Part III is a more detailed walk-through of each component and may yield a larger at-risk figure. You can skip Part II and go straight to Part III if you prefer.1Internal Revenue Service. Instructions for Form 6198 If you completed Form 6198 last year, your ending at-risk amount becomes this year’s starting point, and current-year adjustments produce the updated figure.
Part IV is the payoff. Line 20 takes the at-risk amount from whichever method you used (the larger of line 10b or line 19b). Line 21 compares that at-risk amount to your loss from Part I and gives you the smaller of the two. That’s your deductible loss.5Internal Revenue Service. Form 6198 (Rev. November 2025) Anything above the at-risk amount is suspended.
What Happens to Losses You Can’t Deduct
Losses that exceed your at-risk amount aren’t lost. They’re treated as a deduction from the same activity in the following tax year.2Office of the Law Revision Counsel. 26 U.S. Code 465 – Deductions Limited to Amount at Risk The suspended amount rolls forward automatically until your at-risk amount grows enough to absorb it. You can increase your at-risk amount by putting in more cash, taking on qualifying debt, or earning income from the activity.
Selling the property increases the at-risk amount in the year of sale by the gain, which can free up suspended losses. A sale at a significant gain often clears out previously suspended at-risk losses in one shot.
Where the At-Risk Rule Sits Among Other Loss Limits
The at-risk limit isn’t the only hurdle a rental loss has to clear. The limitations run in a fixed order, and each has its own suspended-loss pool.6Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
- Basis limitations come first. Losses you receive through a partnership or S corporation can’t exceed your basis in that entity. Anything beyond basis is suspended before the at-risk rules apply.
- At-risk rules come second. Losses that survive the basis test face Form 6198, and your deduction is capped at your at-risk amount.
- Passive activity rules come third. Losses that clear the at-risk hurdle move to Form 8582 and get tested against the passive activity loss rules. Most rentals are passive by default.
- The excess business loss limitation comes last. For tax years through 2028, aggregate business losses above the annual threshold are converted to a net operating loss carryforward.7Internal Revenue Service. 2025 Instructions for Form 461
The ordering matters because a loss blocked at one stage never reaches the next, and the carryforward rules differ at each stage.
Recapture When Your At-Risk Amount Goes Negative
Your at-risk amount can drop below zero. Refinancing with debt that doesn’t qualify, taking large distributions, or reducing your recourse debt in a way that flips your economic exposure negative can all do it. When your at-risk amount goes below zero, you have to recognize income equal to the negative amount, effectively returning a portion of losses you deducted in earlier years.8eCFR. 26 CFR 1.1502-45 – Limitation on Losses to Amount at Risk The Form 6198 instructions point to Publication 925 for the recapture calculation.
The most common trigger is a cash-out refinance where the new loan doesn’t qualify as nonrecourse financing from a qualified lender. The new debt may be larger than the old, but if it doesn’t meet the requirements, your at-risk amount drops by the difference and can slide negative.
Penalties for Overstating the Deduction
Claiming a loss larger than your at-risk amount produces an underpayment of tax, and that can trigger the accuracy-related penalty. The IRS imposes a 20% penalty on underpayments resulting from negligence or a substantial understatement of income tax.9Internal Revenue Service. Accuracy-Related Penalty For individuals, a substantial understatement exists when the understatement exceeds the greater of 10% of the correct tax or $5,000. Rental owners who deduct large losses without checking their at-risk status sit squarely in the penalty zone, particularly when seller financing or related-party debt is involved and the taxpayer assumed all debt counted.