At-Risk Limitations for K-1 Losses
The at-risk limitations are the second of three limitations applied to income producing activities. It is similar to the Basis Limitation, in that one of the major components of the “Amount At-Risk” is the amount invested in the activity. Under the basis limitation, losses are limited to amount invested in the activity. The at-risk limits, on the other hand, limit losses to amounts the investor has actually put at-risk. This can differ from amount invested because of loan guarantees, stop-loss agreements, or nonrecourse loans.
For example, a partner increases his adjusted basis for his share of nonrecourse loans. Nonrecourse loans are loans for which no partner is personally liable. Since the partner is not personally liable for the nonrecourse loans, he is not considered “at-risk” for the loan, therefore the amount of losses allowed under the basis limitations will be higher by the amount of the nonrecourse loan. Some nonrecourse loans, called qualified nonrecourse financing, do increase amount at-risk. Qualified nonrecourse financing are loans that are secured by real estate that is used in the activity.
The at-risk limits are computed on Form 6198. In part I of the form, current year income and loss is combined with prior year amounts that were disallowed by the at-risk limitations. Current and prior year loss is allowed to the extent of current year income. Any prior and current year loss in excess of current year income is limited to amount at-risk.
If partner or shareholder distributions cause the amount at-risk to become negative, gain is recognized to the extent losses have been allowed by at-risk in prior years and have not already been recaptured. The amount of at-risk recapture is carried over to following year as a deduction, and will be allowed as a deduction in the following year if the amount at-risk increases. (IRC 465(d))
There is no guidance as far as the character of the at-risk recapture. One approach would be to characterize the at-risk recapture according to the type of losses deducted in prior years. (1231 loss, long-term capital loss, etc).
The at-risk recapture does not increase the partners or shareholders basis. IRC 705(a)(1)(a) spells out the rules for determining the partners basis. It states that the partner's basis is increased by his distributive share of "A) taxable income of the partnership as determined under section 703(a)".Section 703(a) defines the taxable income of the partnership. Since the at-risk recapture is not a partnership item, it does not go into the computation of partnership income under 703(a) and therefore does not increase the partners basis