Understanding tax laws can be complex, especially when dealing with business losses. One concept that often arises is the “at-risk loss carryover.” What Is An At Risk Loss Carryover? Simply put, it refers to business losses that a taxpayer couldn’t deduct in a previous year due to the “at-risk” rules, and can potentially deduct in a future year if their at-risk amount increases.
Decoding the At-Risk Loss Carryover
The “at-risk” rules are designed to limit a taxpayer’s deductible losses from a business to the amount they could actually lose. This prevents taxpayers from deducting losses exceeding their investment in a business. This means that if your losses exceed your at-risk amount, you can’t deduct the excess loss in the current year. Instead, that excess loss becomes an at-risk loss carryover, which you can potentially deduct in future years. It is important to accurately calculate and track your at-risk amount to maximize your potential tax savings.
Determining your at-risk amount involves calculating the money and the adjusted basis of property you’ve contributed to the business. It also includes amounts you’ve borrowed for use in the business, to the extent that you’re personally liable for repayment or have pledged property as security for the debt. However, certain types of debt, such as nonrecourse debt (debt where you’re not personally liable), generally aren’t included in your at-risk amount. Here’s a simplified breakdown of items that generally increase and decrease your at-risk amount:
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Increases:
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Cash contributions
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Adjusted basis of contributed property
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Recourse debt (for which you are personally liable)
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Your share of the business’s income
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Decreases:
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Withdrawals from the business
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Your share of the business’s losses
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Nonrecourse debt used to finance the business
To illustrate, imagine you invest $10,000 in a business. The first year, the business incurs a $15,000 loss. Because you are only at risk for $10,000, you can only deduct $10,000 of the loss. The remaining $5,000 becomes an at-risk loss carryover. In the following year, if you increase your at-risk amount (perhaps by contributing more capital or becoming personally liable for a debt), you can then deduct some or all of the $5,000 carryover. Keep in mind that the at-risk rules apply separately to each activity. This means you can’t offset losses from one activity with amounts at risk in another, unrelated activity. Always consult a tax professional.
For more detailed guidance on at-risk rules and loss carryovers, refer to IRS Publication 925, Passive Activity and At-Risk Rules. The publication contains detailed information and examples to help you determine if you have an at-risk loss carryover and how to calculate the deductible amount.