8005 / Under the at risk rules, how is an individual’s “amount at risk” determined?

In the most general terms, an individual is “at risk” to the extent the individual is not protected against the loss of the money or other property contributed to the activity. If the individual borrows the money contributed to the activity, the individual is “at risk” only to the extent he or she is not protected against the loss of the borrowed amount (i.e., to the extent of the individual’s personal liability for repayment of such amount).¹ A partner’s “amount at risk” is not affected by a loan made to the partnership by any other partner.² Payment by a purchaser to the seller for an interest in an activity is treated by the purchaser as a contribution to the activity.³

More specifically, an individual has “at risk” in an activity an amount equal to the total of:⁴ |

1. The amount of money the individual has contributed to the activity. If an individual borrows the money contributed to an activity (or, in the case of a limited partnership, the money with which the interest is purchased), the individual is “at risk” only to the extent he or she is personally liable to repay such amounts, or to the extent he or she pledges as security property not used in the activity.⁵

In the case of a partnership, amounts required to be contributed under the partnership agreement are not “at risk” until the contribution is actually made. Similarly, a partner’s amount at risk does not include the amount of a note that is payable to the partnership and on which the partner is personally liable until such time as the proceeds are applied to the activity.⁶

2. The individual’s tax basis (for determining loss) in any property (other than money) contributed to the activity. If the individual has borrowed funds to purchase the property contributed to the activity, the individual will be “at risk” with respect to such property only to the extent that he or she would have been “at risk” had the borrowed funds been contributed instead of the purchased property.⁷

The basis of a limited partnership interest did not include the liability created by a limited partner’s written obligation (an interest-bearing nonrecourse note) given as part of the purchase price of the interest where it was payable only from, and to the extent of, cash distributions from the production activities of the partnership.⁸

3. Amounts borrowed in the conduct of the activity for use in the activity to the extent the individual is personally liable for repayment. If an individual is personally liable for amounts borrowed in the conduct of the activity, the individual is “at risk” to the extent of such amounts regardless of the fact that property used in the activity is also pledged as security for such amounts.⁹The fact that the partnership or other partners are in the chain of liability does not reduce the amount a partner is “at risk” if the partner bears ultimate responsibility.¹⁰ In the case of liabilities on which the individual is initially personally liable (i.e., recourse liabilities), but which after the occurrence of some event or lapse of a period of time will become nonrecourse, the individual is considered “at risk” during the period of recourse liability if (a) the borrowing arrangement was motivated primarily for business reasons and not tax avoidance, and (b) the arrangement is consistent with the normal commercial practice of financing the activity for which the money was borrowed.¹¹ As to the effect of repayment by the individual of a liability for which he is personally liable, see Proposed Treasury Regulation Section 1.465-24(b).¹²
4. Amounts borrowed for use in the activity and for which the individual is not personally liable for repayment, but only to the extent the individual pledges property that is not used in the activity as security for repayment. In this case the individual is “at risk” only to the extent that the amount of the liability does not exceed the fair market value of the pledged property. If the fair market value of the security changes after the loan is made, a redetermination of the amount at risk must be made using the new fair market value.¹³ Property will not be treated as security if such property itself is financed (directly or indirectly) by loans secured with property contributed to the activity.¹⁴ If a taxpayer repays a loan for which he or she is personally liable with assets already in the activity, the taxpayer’s amount at risk in the activity will be decreased by the adjusted basis¹⁵ of such assets.¹⁶ As to the effect of contributing the security to the activity, see Proposed Treasury Regulation Section 1.465-25.

Notwithstanding the fact that an individual is personally liable (as in (3), above) or has pledged security for borrowed funds (as in (4), above), borrowed amounts cannot (except to the extent provided in future regulations) be considered at risk (1) if they are borrowed from a person who has an interest (other than as a creditor) in the activity, or (2) if they are borrowed from a person who is related to another person (other than the taxpayer) having an interest in the activity.¹⁷

For purposes of the foregoing rule, a “related” person generally includes the following: members of a family (i.e., an individual and his brothers, sisters, spouse, ancestors, and lineal descendants); a partnership and any partner owning, directly or indirectly, 10 percent of the capital or profits interests in such partnership; two partnerships in which the same persons own, directly or indirectly, more than 10 percent of the capital or profits interest; an individual and a corporation in which such individual owns, directly or indirectly, more than 10 percent in value of the outstanding stock; two corporations that are members of the same controlled group; a grantor and a fiduciary of the same trust; fiduciaries of trusts that have a common grantor; a fiduciary of a trust and the beneficiaries of that trust, or beneficiaries of another trust if both trusts have the same grantor; a fiduciary of a trust and a corporation if more than 10 percent in value of outstanding stock is owned, directly or indirectly, by the trust or by the grantor of the trust; a person and a tax-exempt organization controlled by such person or family of such person; a corporation and a partnership in which the same person owns a more-than-10 percent interest (by value of stock in the case of the corporation and by capital or profits interest in the case of the partnership); two or more S corporations if more than 10 percent of the stock (by value) of each is owned by the same person; an S corporation and a C corporation if more than 10 percent of the stock (by value) is owned by the same person; and an executor of an estate and a beneficiary of such estate (except in the case of a sale or exchange in satisfaction of a pecuniary bequest).¹⁸

Amounts borrowed from family members or other persons related to the taxpayer may be considered at risk under certain limited circumstances.¹⁹