At-Risk Limits The at-risk rules limit your losses from most activities to youramount at risk in the activity. You treat any loss that is disallowedbecause of the at-risk limits as a deduction from the same activity inthe next tax year. If your losses from an at-risk activity areallowed, they are subject to recapture in later years if your amountat risk is reduced below zero. Caution: You must apply the at-risk rules before thepassive activity rules discussed in the first part of thispublication. Loss defined.A loss is the excess of allowable deductions from the activity forthe year (including depreciation or amortization allowed or allowableand disregarding the at-risk limits) over income received or accruedfrom the activity during the year. Income does not include income fromthe recapture of previous losses (discussed, later, underRecapture Rule). Form 6198.Use Form 6198 to figure how much loss from an activity you candeduct. You must file Form 6198 with your tax return if: You have a loss from any part of an activity that is coveredby the at-risk rules, and You are not at risk for some of your investment in theactivity. Loss limits for partners and S corporation shareholders.Three separate limits apply to a partner's or shareholder'sdistributive share of a loss from a partnership or S corporation. Thelimits determine the amount of the loss each partner or shareholdercan deduct on his or her own return. These limits and the order inwhich they apply are: The adjusted basis of: The partner's partnership interest, or The shareholder's stock plus any loans the shareholder makesto the corporation, The at-risk rules, and The passive activity rules. See Limits on Losses in Publication 541, andLimitations on Losses, Deductions, and Credits inShareholder's Instructions for Schedule K-1 (Form 1120S). Who Is Affected? The at-risk limits apply to individuals (including partners and Scorporation shareholders) and to certain closely held corporations(other than S corporations). Closely held corporation.For the at-risk rules, a corporation is a closely held corporationif at any time during the last half of the tax year, more than 50% invalue of its outstanding stock is owned directly or indirectly by orfor five or fewer individuals. To figure if more than 50% in value of the stock is owned by fiveor fewer individuals, apply the following rules. Stock owned directly or indirectly by or for a corporation,partnership, estate, or trust is considered owned proportionately byits shareholders, partners, or beneficiaries. An individual is considered to own the stock owned directlyor indirectly by or for his or her family. Family includes onlybrothers and sisters (including half-brothers and half-sisters), aspouse, ancestors, and lineal descendants. If a person holds an option to buy stock, he or she isconsidered to be the owner of that stock. When applying rule (1) or (2), stock considered owned by aperson under rule (1) or (3) is treated as actually owned by thatperson. Stock considered owned by an individual under rule (2) is nottreated as owned by the individual for again applying rule (2) toconsider another the owner of that stock. Stock that may be considered owned by an individual undereither rule (2) or (3) is considered owned by the individual underrule (3). Activities Coveredby the At-Risk Rules If you are involved in one of the following activities as a tradeor business or for the production of income, you are subject to theat-risk rules. Farming. Exploring for, or exploiting, oil and gas. Holding, producing, or distributing motion picture films orvideo tapes. Leasing section 1245 property, including personal propertyand certain other tangible property that is depreciable oramortizable. See Section 1245 property, later. Exploring for, or exploiting, geothermal deposits (for wellsstarted after September 1978). Any other activity not included in (1) through (5) that iscarried on as a trade or business or for the production ofincome. Section 1245 property.Section 1245 property includes any property that is or has beensubject to depreciation or amortization and that is: Personal property, Other tangible property (other than a building or itsstructural components) that is: Used in manufacturing, production, or extraction or infurnishing transportation, communications, electrical energy, gas,water, or sewage disposal, A research facility used for the activities in (a), or A bulk storage facility used for the activities in (a), A single purpose agricultural or horticultural structure, or A storage facility (other than a building or its structuralcomponents) used for the distribution of petroleum. Exception for holding real property placed in service before1987.The at-risk rules do not apply to the holding of real propertyplaced in service before 1987. They also do not apply to the holdingof an interest acquired before 1987 in a pass-through entity engagedin holding real property placed in service before 1987. This exceptiondoes not apply to holding mineral property. Personal property and services that are incidental to making realproperty available as living accommodations are included in theactivity of holding real property. For example, making personalproperty, such as furniture, and services available when renting ahotel or motel room or a furnished apartment is considered incidentalto making real property available as living accommodations. Exception for equipment leasing by a closely heldcorporation.If a closely held corporation is actively engaged inequipment leasing, the equipment leasing is treated as a separateactivity not covered by the at-risk rules. A closely held corporationis actively engaged in equipment leasing if 50% or more of its grossreceipts for the tax year are from equipment leasing. Equipmentleasing means the leasing, purchasing, servicing, and selling ofequipment that is section 1245 property. However, equipment leasing does not include the leasingof master sound recordings and similar contractual arrangements fortangible or intangible assets associated with literary, artistic, ormusical properties, such as books, lithographs of artwork, or musicaltapes. A closely held corporation cannot exclude these leasingactivities from the at-risk rules nor count them as equipment leasingfor the gross receipts test. The equipment leasing exclusion is also not available for leasingactivities related to other at-risk activities, such as motion picturefilms and video tapes, farming, oil and gas properties, and geothermaldeposits. For example, if a closely held corporation leases a videotape, it cannot exclude this leasing activity from the at-risk rulesunder the equipment leasing exclusion. Controlled group of corporations.A controlled group of corporations is subject to special rules forthe equipment leasing exclusion. See section 465(c) of the InternalRevenue Code. Special exception for qualified corporations.A qualified corporation is not subject to the at-risk limits forany qualifying business carried on by the corporation. Each qualifyingbusiness is treated as a separate activity. A qualified corporation is a closely held corporation,defined, earlier, under Who Is Affected?, that is not: A personal holding company, A foreign personal holding company, or A personal service corporation (defined in section 269A(b)of the Internal Revenue Code, but determined by substituting 5% for10%). Qualifying business.A qualifying business is any active business if all ofthe following apply. During the entire 12-month period ending on the last day ofthe tax year, the corporation had at least: One full-time employee whose services were in the activemanagement of the business, and Three full-time nonowner employees whose services weredirectly related to the business. A nonowner employee does not ownmore than 5% in value of the outstanding stock of the corporation atany time during the tax year. (The rules for constructive ownership ofstock in section 318 of the Internal Revenue Code apply. However, inapplying these rules, an owner of 5% or more, rather than 50% or more,of the value of a corporation's stock is considered to own aproportionate share of any stock owned by the corporation.) Deductions due to the business that are allowable to thecorporation as business expenses and as contributions to certainemployee benefit plans for the tax year exceed 15% of the gross incomefrom the business. The business is not an excluded business.Generally, an excluded business means equipment leasing asdefined, earlier, under Exception for equipment leasing by aclosely held corporation, and any business involving the use,exploitation, sale, lease, or other disposition of master soundrecordings, motion picture films, video tapes, or tangible orintangible assets associated with literary, artistic, musical, orsimilar properties. Separation of Activities Generally, you treat your activity involving each film or videotape, item of leased section 1245 property, farm, oil and gasproperty, or geothermal property as a separate activity. Inaddition, each investment that is not a part of a trade or business istreated as a separate activity. Leasing by a partnership or S corporation.For a partnership or S corporation, treat all leasing of section1245 property that is placed in service in any tax year of thepartnership or S corporation as one activity. Aggregation of Activities Trade or business activities described in (6) under ActivitiesCovered by the At-Risk Rules, earlier, are treated as oneactivity if: You actively participate in the management of thetrade or business, or The trade or business is carried on by a partnership or Scorporation and 65% or more of its losses for the tax year areallocable to persons who actively participate in the management of thetrade or business. Similar rules apply to activities described in (1) through (5)of that discussion. Active participation.Active participation depends on all the facts and circumstances.Factors that indicate active participation include making decisionsinvolving the operation or management of the activity, performingservices for the activity, and hiring and discharging employees.Factors that indicate a lack of active participation include lack ofcontrol in managing and operating the activity, having authority onlyto discharge the manager of the activity, and having a manager of theactivity who is an independent contractor rather than an employee. Partners and S corporation shareholders.Partners or shareholders may aggregate activities of theirpartnership or S corporation within each of the following categories: Films and video tapes, Farms, Oil and gas properties, and Geothermal properties. For example, if a partnership or S corporation produces two filmsor video tapes, the partners or S corporation shareholders may treatthe production of both films or video tapes as one activity forpurposes of the at-risk rules. At-Risk Amounts You are at risk in any activity for: The money and adjusted basis of property you contribute tothe activity, and Amounts you borrow for use in the activity if: You are personally liable for repayment, or You pledge property (other than property used in theactivity) as security for the loan. Amounts borrowed.You are at risk for amounts borrowed to use in the activity if youare personally liable for repayment. You are also at risk if theamounts borrowed are secured by property other than property used inthe activity. In this case, the amount considered at risk is the netfair market value of your interest in the pledged property. The netfair market value of property is its fair market value (determined onthe date the property is pledged) less any prior (or superior) claimsto which it is subject. However, no property will be taken intoaccount as security if it is directly or indirectly financed by debtthat is secured by property you contributed to the activity. Caution: If you borrow money to finance a contribution to an activity, youcannot increase your amount at risk by the contribution and the amountborrowed to finance the contribution. You may increase your at-riskamount only once. Certain borrowed amounts excluded.Even if you are personally liable for the repayment of a borrowedamount or you secure a borrowed amount with property other thanproperty used in the activity, you are not considered at risk if youborrowed the money from a person having an interest in the activity orfrom someone related to a person (other than you) having an interestin the activity. This does not apply to: Amounts borrowed by a corporation from its shareholders, Amounts borrowed from a person having an interest in theactivity as a creditor, or An activity described in (6) under Activities Coveredby the At-Risk Rules, earlier. Related persons.Related persons include: Members of the family, but only brothers and sisters,half-brothers and half-sisters, a spouse, ancestors (parents,grandparents, etc.), and lineal descendants (children, grandchildren,etc.), Two corporations that are members of the same controlledgroup of corporations determined by applying a 10% ownership test, The fiduciaries of two different trusts, or the fiduciaryand beneficiary of two different trusts, if the same person is thegrantor of both trusts, A tax-exempt educational or charitable organization and aperson who directly or indirectly controls it (or a member of whosefamily controls it), A corporation and an individual who owns directly orindirectly more than 10% of the value of the outstanding stock of thecorporation, A trust fiduciary and a corporation of which more than 10%in value of the outstanding stock is owned directly or indirectly byor for the trust or by or for the grantor of the trust, The grantor and fiduciary, or the fiduciary and beneficiary,of any trust, A corporation and a partnership if the same persons own over10% in value of the outstanding stock of the corporation and more than10% of the capital interest or the profits interest in thepartnership, Two S corporations if the same persons own more than 10% invalue of the outstanding stock of each corporation, An S corporation and a regular corporation if the samepersons own more than 10% in value of the outstanding stock of eachcorporation, A partnership and a person who owns directly or indirectlymore than 10% of the capital or profits of the partnership, Two partnerships if the same persons directly or indirectlyown more than 10% of the capital or profits of each, Two persons who are engaged in business under commoncontrol, and An executor of an estate and a beneficiary of thatestate. To determine the direct or indirect ownership of the outstandingstock of a corporation, apply the following rules. Stock owned directly or indirectly by or for a corporation,partnership, estate, or trust is considered owned proportionately byor for its shareholders, partners, or beneficiaries. Stock owned directly or indirectly by or for an individual'sfamily is considered owned by the individual. The family of anindividual includes only brothers and sisters, half-brothers andhalf-sisters, a spouse, ancestors, and lineal descendants. Any stock in a corporation owned by an individual (otherthan by applying rule (2)) is considered owned directly or indirectlyby the individual's partner. When applying rule (1), (2), or (3), stock considered ownedby a person under rule (1) is treated as actually owned by thatperson. But, if a person constructively owns stock because of rule (2)or (3), he or she does not own the stock for purposes of applyingeither rule (2) or (3) to make another person the constructive ownerof the same stock. Effect of government price support programs.A government target price program (such as provided by theAgriculture and Consumer Protection Act of 1973) or other governmentprice support programs for a product that you grow does not, withoutagreements limiting your costs, reduce the amount you have at risk. Effect of increasing amounts at risk in subsequent years.Any loss that is allowable in a particular year reduces yourat-risk investment (but not below zero) as of the beginning of thenext tax year and in all succeeding tax years for that activity. Ifyou have a loss that is more than your at-risk amount, the lossdisallowed will not be allowed in later years unless you increase yourat-risk amount. Losses that are suspended because they are greaterthan your investment that is at risk are treated as a deduction forthe activity in the following year. Consequently, if your amount atrisk increases in later years, you may deduct previously suspendedlosses to the extent that the increases in your amount at risk exceedyour losses in later years. However, your deduction of suspendedlosses may be limited by the passive loss rules. Amounts Not At Risk You are not considered at risk for amounts protected against lossthrough nonrecourse financing, guarantees, stop loss agreements, orother similar arrangements. Nonrecourse financing.Nonrecourse financing is financing for which you are not personallyliable. If you borrow money to contribute to an activity and thelender's only recourse is to your interest in the activity or theproperty used in the activity, the loan is a nonrecourse loan. You are not considered at risk for your share of any nonrecourseloan used to finance an activity or to acquire property used in theactivity unless the loan is secured by property not used in theactivity. However, you are considered at risk for qualified nonrecoursefinancing secured by real property used in the holding of realproperty. Qualified nonrecourse financing is financing for which no one ispersonally liable for repayment and that is: Borrowed by you in connection with the activity of holdingreal property, Secured by real property used in the activity, Not convertible from a debt obligation to an ownershipinterest, and Loaned or guaranteed by any federal, state, or localgovernment, or borrowed by you from a qualified person. Other types of property used as security.The rules in the next two paragraphs apply to any financingincurred after August 3, 1998. You can also choose to apply theserules to financing you obtained before August 4, 1998. If you do that,you must reduce the amounts at risk as a result of applying theserules to years ending before August 4, 1998, to the extent theyincrease the losses allowed for those years. In determining whether qualified nonrecourse financing is securedonly by real property used in the activity of holding real property,disregard property that is incidental to the activity of holding realproperty. Also disregard other property if the total gross fair marketvalue of that property is less than 10% of the total gross fair marketvalue of all the property securing the financing. For this purpose, treat yourself as owning directly yourproportional share of the assets in any partnership in which you own,directly or indirectly, an equity interest. Qualified person.A qualified person actively and regularly engages in the businessof lending money. The most common example is a bank. A qualified person is not: A person related to you in one of the ways listed underRelated persons, earlier. However, a person related to youmay be a qualified person if the nonrecourse financing is commerciallyreasonable and on the same terms as loans involving unrelated persons. A person from which you acquired the property or a personrelated to that person. A person who receives a fee due to your investment in thereal property or a person related to that person. Other loss limiting arrangements.Any capital you have contributed to an activity is not at risk ifyou are protected against economic loss by an agreement or arrangementfor compensation or reimbursement. For example, you are not at risk ifyou will be reimbursed for part or all of any loss because of abinding agreement between yourself and another person. Example 1.Some commercial feedlots reimburse investors against any losssustained on sales of the fed livestock above a stated dollar amountper head. Under such "stop loss" orders, the investor is at riskonly for the portion of the investor's capital for which the investoris not entitled to a reimbursement. Example 2.You are personally liable for a mortgage, but you separately obtaininsurance to compensate you for any payments you must actually makebecause of your personal liability. You are considered at risk only tothe extent of the uninsured portion of the personal liability to whichyou are exposed. You can include in the amount you have at risk theamount of any premium which you paid from your personal assets for theinsurance. However, if you obtain casualty insurance or insuranceprotecting yourself against tort liability, it does not affect theamount you are otherwise considered to have at risk. Reductions ofAmounts At Risk The amount you have at risk in any activity is reduced by anylosses allowed in previous years under the at-risk rules. It may alsobe reduced because of distributions you received from the activity,debts changed from recourse to nonrecourse, or the initiation of astop-loss or similar agreement. If the amount at risk is reduced belowzero, your previously allowed losses are subject to recapture, asexplained next. Recapture Rule If the amount you have at risk in any activity at the end of anytax year is less than zero, you must recapture at least part of yourpreviously allowed losses. You do this by adding to your income fromthe activity for that year the smaller of the following amounts: The negative at-risk amount (treated as a positive amount),or The total amount of losses deducted in previous tax yearsbeginning after 1978, minus any amounts you previously added to yourincome from that activity under this recapture rule. Do not use the recapture income to reduce any net loss from theactivity for the tax year. Instead, treat the recaptured amount as adeduction for the activity in the next tax year. Pre-1979 activity.If the amount you had at risk in an activity at the end of your taxyear that began in 1978 was less than zero, you apply the precedingrule for the recapture of losses by substituting that negative amountfor zero. For example, if your at-risk amount for that tax year wasminus $50, you will recapture losses only when your at-risk amountgoes below minus $50.