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At-Risk Rules (Portfolio 550)

Tax Management Portfolio, At-Risk Rules, No. 550-4th, analyzes the rules that limit the deductibility of loss from an activity to the amount with respect to which a taxpayer is “at-risk.” Congress enacted the at-risk rules in response to the widespread use of nonrecourse debt to create tax losses in excess of a taxpayer's actual cash investment in an activity.

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DESCRIPTION

Tax Management Portfolio, At-Risk Rules, No. 550-4th, analyzes the rules that limit the deductibility of loss from an activity to the amount with respect to which a taxpayer is “at-risk.” Congress enacted the at-risk rules in response to the widespread use of nonrecourse debt to create tax losses in excess of a taxpayer's actual cash investment in an activity.
Generally, the at-risk rules apply to all individuals and to closely-held C corporations in which five or fewer individuals own more than 50% of the stock. Although the at-risk rules do not technically apply to S corporations and partnerships/LLCs, the at-risk rules do apply to S corporation shareholders as well as to partners/members in partnerships/LLCs. Losses attributable to “qualified businesses” conducted by “qualified C corporations” are exempt from the at-risk rules.
A taxpayer's at-risk amount includes the amount of money and the adjusted basis of other property the taxpayer contributes to the activity. Amounts borrowed for use in an activity are included in the at-risk amount to the extent the taxpayer is personally liable for repayment or has pledged property other than property used in the activity as security for the debt.
A taxpayer is not considered at risk with respect to amounts borrowed in connection with certain activities if funds are borrowed from a person who has an interest in the activity other than a creditor interest. A taxpayer is also not considered at risk with respect to amounts protected against loss through nonrecourse financing, guarantees, stop-loss agreements, or other similar arrangements.
A special rule applies with respect to certain nonrecourse loans that are incurred in connection with the activity of holding real property. A taxpayer is considered to be at risk for its share of “qualified nonrecourse financing” which is secured by real property used in the activity. This portfolio provides a thorough discussion of this important exception.
Taxpayers may carry forward losses suspended under the at-risk rules indefinitely. The taxpayer may use the disallowed loss in a subsequent year when the taxpayer has a sufficient at-risk amount. In addition, a taxpayer may use suspended losses to offset any gain recognized upon disposition of the investment activity.


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AUTHORS

LISA MARIE STARCZEWSKI
Lisa Marie Starczewski, Smith College, B.A. (magna cum laude, 1985); Villanova University, J.D. (summa cum laude, 1988); Editor-in-Chief, Villanova Law Review (1987–1988); member of adjunct faculty, Villanova University School of Law; former associate, Morgan, Lewis & Bockius; Schnader, Harrison, Segal & Lewis; member, Philadelphia Bar Association Section of Taxation; author, 714 T.M., Partnerships — Allocation of Liabilities; Basis Rules; 752 T.M., Corporate Alternative Minimum Tax; 587T.M., Noncorporate Alternative Minimum Tax; 621 T.M., IRS National Office Procedures — Rulings, Closing Agreements; 565 T.M., Installment Sales; co-author, 517 T.M., Scholarships and Educational Expenses; 503 T.M., Deductions: Overview and Conceptual Aspects, and 504 T.M., Deduction Limitations: General; author and co-author of numerous book chapters; contributor to various tax publications.

TABLE OF CONTENTS

Detailed Analysis

I. History of At-Risk Legislation

A. IRS's Nonstatutory Attacks on Nonrecourse Debt

B. Tax Reform Act of 1976

C. Revenue Act of 1978

D. Economic Recovery Tax Act of 1981

E. Subchapter S Revision Act of 1982

F. Deficit Reduction Act of 1984

G. Tax Reform Act of 1986

H. Revenue Reconciliation Act of 1990

I. Regulations

II. Overview of At-Risk Rules

A. General Principle and Operation of At-Risk Rules

1. General Loss Limitation

2. Loss Carryover

3. Character of Disallowed and Carried-Over Losses

4. Recapture Income

B. Taxpayers Subject to At-Risk Rules

C. Activities to Which At-Risk Rules Apply

D. Determination of Taxpayer's Amount At Risk

E. Relationship to Passive Activity Loss Rules

F. Special Partnership/LLC Issues

1. Relationship Between At-Risk Amount and Partnership Basis

2. Relationship Between At-Risk Rules and Partnership Liability Allocation Regulations

3. Procedure for Controversy with the IRS

G. Alternative Minimum Tax Treatment

III. Taxpayers Subject to the At-Risk Rules

A. In General

B. Applicability to Certain Closely Held C Corporations

1. Determining Whether Stock Ownership Test Is Met

2. Corporations Filing Consolidated Returns

C. Treatment of Pass-Through Entities

D. Foreign Persons

E. Other Entities

IV. Activities to Which the At-Risk Rules Apply

A. In General

B. Corporations Primarily Engaged in Equipment Leasing

C. Active Business Exemption for C Corporations

1. In General

2. Qualifying C Corporations

3. Qualifying Businesses

a. In General

b. Corporate Partners

c. Affiliated Group Rule

V. Determining Separate Activities

A. Background

B. General Rule: Activities Treated as Separate

C. Equipment Leasing

D. Active Participation Activities

E. Activities Conducted Through Partnerships and S Corporations

F. Real Property

G. Relationship to “Activity” Regulations for Passive Losses

VI. Determining the Amount at Risk

A. In General

B. Contributions of Money

1. In General

2. Loaned Amounts

a. Rules Applicable to Partnerships/LLCs

b. Rules Applicable to S Corporations

C. Contributions of Property

1. Contributions of Unencumbered Property

2. Contributions of Encumbered Property

3. Contribution of Property Used as Security for Nonrecourse Loan Used in Activity

4. Contributions of Notes

D. Borrowed Amounts

1. In General

2. Establishing Personal Liability for Debt

a. In General

b. Partner/LLC Member's Personal Liability for Indebtedness

c. Liabilities Not Recognized for Tax Purposes

d. Prepaid Income

e. Contingent Liabilities

f. Guarantees

g. Anti-Avoidance Rules

(1) Amounts Protected Against Loss

(2) Other Anti-Avoidance Rules

3. Loans from Interested/Related Parties

a. In General

b. Exception for Certain Nonrecourse Debt

4. Convertible Loans

5. Effect of Repayment of Debt

a. Repayment by Entity Conducting Activity

b. Repayment by Taxpayer

6. Pledged Property

a. In General

b. Nonrecourse Loans Secured by Property Used in Activity

c. Nonrecourse Loans Secured by Property Not Used in Activity

E. Items That Change Amount at Risk

1. Increases to Amount at Risk

2. Decreases to Amount at Risk

VII. Qualified Nonrecourse Financing

A. In General

B. “Activity” of Holding Real Property

C. Rules Applicable to Property Used as Security

D. Permissible Types of Lenders/Guarantors

E. Absence of Personal Liability

F. Absence of “Convertible Debt”

G. Allocating Partnership Qualified Nonrecourse Financing

VIII. Effect of Transfer/Disposition of Activity on Amount at Risk

A. Effect on Transferor

B. Effect on Purchaser of Activity

C. Effect on Transferee with Carryover Basis

D. Effect of Transfer by Reason of Death

IX. At-Risk Limitation on Property-Based Tax Credits

A. In General

B. Credit Base

C. Applicable Property

1. In General

2. Exception for Qualified Energy Property

D. Nonqualified Nonrecourse Financing

1. In General

2. Definition of “Qualified Person”

a. In General

b. Special Rule Applicable to Low-Income Housing Credit

3. Definition of “Related Person”

4. Subsequent Decreases in Nonqualified Nonrecourse Financing

5. Subsequent Increases in Nonqualified Nonrecourse Financing

E. Application of § 49 At-Risk Rules to Partnerships and S Corporations

F. Lessor Pass-Through of Certain Credits to Lessee

1. Lessor Election

2. Limitations on Lessee's Credit


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Preamble to Proposed Regs. § § 1.465-1(a) through 1.465-95(b) 44 Fed. Reg. 32235 (6/5/79)

Worksheet 2 General Explanation of the Tax Reform Act of 1976 Prepared by the Staff of the Joint Committee on Taxation (Excerpts)

Worksheet 3 Legislative History of the Tax Reform Act of 1986

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Public Laws:

Legislative History:

Other IRS Materials:

Treasury Rulings:

Cases:

UNOFFICIAL

Periodicals:

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