Section 465 At-Risk Rules: Non-Recourse Debt and Form 6198

The Section 465 at-risk rules cap the losses you can deduct from a business or income-producing activity at the amount you actually stand to lose in it. Anything above that at-risk amount is suspended and carried forward until you add to your risk or the activity generates income. The rule applies activity by activity, and it sits between the basis test and the passive activity rules in the loss-limitation sequence that governs partnerships, S corporations, and sole proprietorships.

Where Section 465 Fits in the Loss Limitation Sequence

A loss from a pass-through business doesn’t become deductible just because it lands on your K-1. It has to clear four filters in a fixed order:

Basis limitation: your deductible loss can’t exceed your tax basis in the partnership or S corporation interest.
At-risk limitation under Section 465: what survives basis is then capped at your at-risk amount in the specific activity.
Passive activity rules under Section 469: what survives at-risk is filtered again if you don’t materially participate.
Excess business loss limitation under Section 461(l): net business losses above a statutory threshold are deferred even after the first three tests.

Each filter hands its allowed amount to the next. A loss stopped at the at-risk stage never reaches the passive activity analysis, and each limitation has its own carryforward and release mechanics.¹

Who and What the Rules Cover

The at-risk rules apply to individuals, including partners and S corporation shareholders receiving losses through their entities. Estates and trusts are subject to the limitation as well. Closely held C corporations are covered when five or fewer individuals own more than 50% of the stock under the Section 542(a) attribution rules; widely held C corporations are generally exempt.²

Coverage is broad. The Form 6198 instructions identify the categories Congress originally targeted: film and videotape production, farming, leasing of depreciable personal property, oil and gas exploration, and geothermal deposits. A sixth catch-all category picks up every other trade, business, or income-producing activity not on that list.³ Narrow exceptions exist for certain equipment-leasing activities of closely held C corporations and for the holding of mineral property interests.

Calculation is done separately for each distinct activity. Losses from one venture cannot be absorbed by the at-risk balance of another, which prevents taxpayers from using a safe investment’s cushion to write off a risky one.

Calculating Your At-Risk Amount

Your at-risk amount is a running tally of what you could actually lose if the activity went to zero. It starts with the cash and adjusted basis of property you contribute, then moves up and down each year.

It increases when you:

Contribute additional cash or property to the activity.
Earn income from the activity that you leave in the business.
Borrow on a recourse basis for use in the activity, meaning you are personally liable from your own assets if the activity can’t repay.²

It decreases when you:

Deduct allowed losses from the activity.
Receive distributions of cash or property.
Reduce recourse debt without replacing it, such as through forgiveness or restructuring into non-recourse debt.²

The calculation resets annually. You take the prior year’s ending balance and layer in the current year’s contributions, income, distributions, and losses. Cumulative deductions should never exceed what you have genuinely put at economic risk.

Which Debt Counts, and Which Doesn’t

Debt is where most of the trouble is. Recourse debt used in the activity generally increases your at-risk amount because you are personally on the hook. Two important carve-outs limit that rule.

Related-Party Borrowing

Amounts borrowed from someone who has an interest in the activity (other than as a creditor) don’t count, and neither do loans from anyone related to a person with such an interest. The related-person definition here uses a 10% ownership threshold rather than the 50% threshold that applies in most other Code sections.² The purpose is to block circular financing where no one actually bears real economic risk. One exception: when a corporation borrows from a shareholder, the shareholder’s status as a shareholder alone doesn’t disqualify the loan.

Non-Recourse Debt

If the lender’s only remedy on default is to take the collateral, and cannot pursue your personal assets, the debt is non-recourse and, as a general rule, does not increase your at-risk amount.² That exclusion hits equipment leasing and other capital-intensive activities hard, where non-recourse financing is common.

Qualified Non-Recourse Financing for Real Property

Real estate gets a major carve-out. Qualified non-recourse financing (QNRF) counts toward your at-risk amount even though you aren’t personally liable. Without it, leveraged real estate losses would rarely be deductible.² All four requirements must be met:

The loan is borrowed in connection with the activity of holding real property, which includes managing, operating, and leasing.
The lender is a “qualified person” regularly engaged in the business of lending money, or a federal, state, or local government entity.²
The loan is secured by the real property used in the activity. Under the regulations, incidental personal property is disregarded, and non-real-property collateral is ignored when its fair market value is less than 10% of the total collateral.⁴
The debt is not convertible into an equity interest or any other obligation during its term.

A related party can be a qualified lender, but only if the loan terms are commercially reasonable and substantially the same as those an unrelated lender would offer.² Seller financing is the common trap: a seller providing a purchase-money mortgage isn’t in the lending business, so seller-financed loans usually fail the qualified-person test.

QNRF applies only to the activity of holding real property. It does not extend to equipment leasing, oil and gas, farming, or any other at-risk category. For those, recourse debt remains the only way to build at-risk basis through borrowing.

S Corporation Shareholders: Guarantees Do Not Count

S corporation shareholders face a trap that partners don’t. In a partnership, a partner’s share of entity recourse debt flows through and can lift the partner’s at-risk amount. In an S corporation, entity-level debt does not flow through, and personally guaranteeing a corporate loan does not create at-risk basis.

The only way an S corporation shareholder builds at-risk basis through debt is by making a direct loan to the corporation from personal funds. A check from your personal account to the S corporation counts; a guarantee of a bank loan the corporation takes out does not. This catches many owners off guard in the early years, when the business is losing money and the owner has guaranteed significant bank debt but still can’t deduct the losses.

Suspended Losses and How They Free Up

When losses exceed your at-risk amount, the excess is suspended. The statute treats the disallowed amount as a deduction from the same activity in the following year, where it runs through the at-risk calculation again.² The carryforward has no expiration.

Suspended losses become deductible when your at-risk amount rises enough to absorb them. Common triggers are additional cash contributions, net income from the activity, or new recourse debt. For real property, refinancing into a loan that meets the QNRF requirements can also restore at-risk basis and free up prior suspended losses.

Recapture When Your At-Risk Amount Goes Negative

If your at-risk amount drops below zero at year-end, Section 465(e) requires you to include the negative amount in gross income as ordinary income from that activity. This usually happens when distributions exceed your remaining at-risk balance or when recourse debt is converted to non-recourse. Recapture effectively reverses the tax benefit of losses you deducted based on risk that no longer exists.⁵

The recapture is capped at the total losses previously allowed from the activity, minus any amounts already recaptured in prior years, so you cannot be forced to report more income than the losses you actually benefited from.⁵ The recaptured amount is then treated as a deduction from the activity in the following year, keeping the rolling calculation intact. Taxpayers who take large distributions or restructure debt near year-end sometimes trigger unexpected recapture because they didn’t check the at-risk balance before closing the transaction.

Reporting on Form 6198

You report the at-risk limitation on IRS Form 6198, attached to your individual return. Filing is required if, during the tax year, you (or a partnership or S corporation in which you held an interest) had amounts not at risk invested in an at-risk activity that produced a loss.³

The form has four parts: current-year profit or loss from the activity, a simplified computation for taxpayers with only at-risk amounts, a detailed computation for those with amounts not at risk, and the final loss allowed after applying the limitation. You file a separate Form 6198 for each activity, which mirrors the activity-by-activity approach the statute requires.

A narrow exception applies if your only at-risk activity falls in the catch-all category (not one of the five specifically listed types) and the only amounts not at risk come from loans borrowed before May 4, 2004; in that case, filing is not required.³ For most current investors, the filing requirement applies whenever losses are on the return.

1
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
2
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
3
Internal Revenue Service. Instructions for Form 6198
4
eCFR. 26 CFR 1.465-27 – Qualified Nonrecourse Financing
5
Office of the Law Revision Counsel. 26 U.S. Code 465 – Deductions Limited to Amount at Risk