Key Takeaways
- At-risk limitations ensure that business owners don't deduct more than their actual investment in a business.
- Only money you're personally liable for is considered "at risk," and, therefore, tax deductible if you have a loss.
- Use Form 6198 to calculate your current year losses, the amount at risk, previous at-risk deductions, and the total allowable deduction for the year.
- You need to file a separate Form 6198 for each business entity, except for S Corporations, which can be combined on one form.
What are at-risk limitations?
A tax deduction reduces your overall tax bill, potentially lessening losses in a business venture. Items such as insurance, property repairs and charitable donations can often be deductible at tax time if they helped you in the course of your business.
However, not all of the money you invest in a business is deductible, due to IRS at-risk limitations. The at-risk rules prevent taxpayers from deducting more than their actual stake in a business. This usually means that for tax purposes, only money you're personally liable for is considered "at risk," and, therefore, tax deductible.
Form 6198 breakdown
To determine the maximum amount you can deduct after suffering a business loss in the tax year, use Form 6198. The four-section form is a worksheet that allows you to:
- Determine your losses for the current year
- Calculate the amount that was at risk in the business
- Compute any at-risk deductions from previous years that you can apply in the current year
- Figure the total allowable deduction you can take for the current tax year
File a separate Form 6198 for each business activity, unless the businesses are S Corporations, in which case the IRS allows you to aggregate all of your investments on a single form.
You are required to file Form 6198 with your tax return if you experience a loss in an income-producing activity deemed by the IRS as at risk. Most business activities are subject to the at-risk limitations.
TurboTax Tip:
In real estate, if only the property secures the debt, it is known as nonrecourse debt. You aren't personally liable for a nonrecourse debt, but it still falls under at-risk limits.
Reason for at-risk rules
Before the IRS implemented at-risk limitations, investors in certain business activities—especially real estate—stood to profit more from losses and tax deductions than from investments gains.
To prevent investors from benefiting from purposeful bad business deals and to promote investments in credible business ventures, Congress acted to limit the deductions investors could take when facing business losses.
A real-world real estate scenario
Real estate investment is a type of business in which you can invest as little or as much money as you'd like, due to mortgage financing options and nonrecourse loans.
Nonrecourse financing pledges a home as collateral, meaning the lender can foreclose on your home if you don't make the payments, but it can't come after you for any uncollected losses. Even though you aren't personally liable for a nonrecourse debt, it still falls under at-risk limits if the property secures the debt.
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