At-Risk Rules for Real Estate Investors

The at-risk rules prevent investors from deducting losses in excess of their actual economic stake in a property. If you borrow nonrecourse debt (a loan where the lender has no personal claim on you) to buy real estate, that borrowed amount usually does not count toward your at-risk basis — except under a special safe harbor for real estate mortgages, which makes real estate lending more accessible than other investments.

Why at-risk rules exist

At-risk rules prevent what Congress saw as abuse: an investor borrowing money at no personal cost (nonrecourse), deducting large paper losses against unrelated income, while the lender bears the actual loss if the property defaults. Without at-risk limits, you could deduct $500,000 in depreciation against your W-2 salary, even if you invested only $50,000 of your own cash and borrowed $450,000 on a nonrecourse basis.

The at-risk rules ensure that the amount of loss you can deduct is limited to the amount you personally have at stake — the amount you would actually lose if the investment failed entirely.

What counts as at-risk

Your at-risk amount includes:

1. Cash you contributed — the clearest at-risk amount
2. Recourse debt — loans where the lender can pursue you personally if the borrower (entity) defaults
3. Personal guarantees — if you personally guarantee a loan to an entity you own, that debt is at-risk
4. Cumulative gains — if the property appreciated and you took out a new loan using the appreciation as collateral, that is generally at-risk

Additionally, for real estate only, nonrecourse mortgages taken out in connection with the acquisition or improvement of real property are treated as at-risk, provided certain conditions are met:

• The mortgage is obtained from a qualified lender (a bank, S&L, or certain other recognized lenders)
• The mortgage is not convertible to equity
• The terms are commercially reasonable
• The lender is not the seller or related to the property owner

This real estate safe harbor is critical: it means that when you buy a rental property with a traditional bank mortgage, that mortgage counts fully toward your at-risk basis, even if the loan is nonrecourse. This is why real estate investing is more accessible than, say, oil-and-gas partnerships or other at-risk activities.

Computing at-risk basis over time

Your at-risk basis is not static. It adjusts each year:

• Increases by additional contributions and income from the activity
• Decreases by distributions, losses taken, and losses not allowed due to the at-risk limit
• Resets when you sell or dispose of the property

Example: You invest $100,000 cash in a rental property and obtain a $300,000 bank mortgage. Your at-risk basis is $400,000 (cash + qualifying nonrecourse real estate mortgage). If you deduct $50,000 in losses in year one, your at-risk basis drops to $350,000. If the property generates $20,000 in net income in year two, your basis rises to $370,000.

Interaction with passive loss rules

At-risk rules and passive loss rules are separate but related. The at-risk limit is a hard floor: you cannot deduct more than your at-risk amount, period. Only losses that pass the at-risk test can then be subject to passive-loss treatment (which might further limit deductibility based on income phase-outs).

Real estate professionals (see Net Operating Loss Rules for Real Estate Professionals) can convert passive rental losses to active losses, bypassing the passive-loss limitation — but even active losses cannot exceed the at-risk amount.

Disallowed and carryforward losses

If you have $50,000 at-risk and claim $80,000 in losses, the extra $30,000 is disallowed. That $30,000 does not disappear: it carries forward indefinitely. In a future year, if your at-risk basis increases (by new contributions or income), you can use the carryforward loss to offset that increase.

Example: Year 1, you have $50,000 at-risk and take $80,000 in losses. $30,000 is disallowed. In Year 2, you contribute an additional $40,000 cash, raising your at-risk basis to $90,000. You can now use the $30,000 carryforward loss from Year 1, plus take up to $60,000 in new losses (limited by the new $90,000 basis). The carryforward does not expire.

Special rules for real property depreciable basis

When you depreciate a rental property, the depreciation is computed on the full basis of the building, not just your at-risk amount. However, deductible depreciation for tax purposes is limited to your at-risk basis. This creates a mismatch on Form 6198: the depreciation you can claim in full (against all income) is capped by at-risk.

This rule prevents using nonrecourse financing to create large depreciation deductions without skin in the game.

Practical planning

Real estate investors should:

• Document the source and amount of personal capital contributed
• Confirm that mortgages are from qualified lenders and meet the safe-harbor conditions
• Track at-risk basis each year on Form 6198, especially if losses exceed basis
• Preserve carryforward losses; they have indefinite life
• Understand that at-risk basis is separate from cost basis for depreciation — you still depreciate the full property value, but deductibility is capped by at-risk

Partnerships and S corporations that invest in real estate must file Form 6198 at the partnership or corporate level and provide each investor their at-risk summary.

See also