At-Risk Rules for Real Estate

The at-risk rules, codified in Section 465 of the tax code, prevent taxpayers from claiming losses in excess of what they have truly invested in a real estate venture. By capping deductible losses to the amount a taxpayer has put at risk, the IRS curbs a favourite tax shelter of the 1970s and 1980s: buying investment properties with borrowed money, then writing off massive losses while keeping the borrowed funds.

The core limit: you can’t lose what you didn’t put in

The at-risk limitation is a straightforward principle: your deductible loss in a business or investment activity cannot exceed the amount you have “at risk”—in other words, the amount you could actually lose. If you invest £50,000 of your own cash in a real estate deal, you can claim losses only up to that £50,000. You cannot claim losses beyond your real economic exposure, even if the property declines in value by millions.

This rule applies to any individual engaging in a “business or investment activity,” which includes real estate ventures. If you are a corporate shareholder or partner in a pass-through entity (like an LLC or partnership), the rule applies at your level, not the entity’s.

What counts as “at risk”

Your at-risk basis includes:

• Equity you contributed: Cash and the adjusted basis of any property you put into the deal.
• Personal debt you incurred: Loans for which you are personally liable. If a lender can pursue you personally if the property fails, that debt counts.
• Retained earnings: Profits from the activity that you have not withdrawn.

What does not count as at risk:

• Nonrecourse debt: Any loan for which you bear no personal liability—the lender’s only recourse is the collateral (the property). Most investment real estate is financed with nonrecourse mortgages. A bank takes a first mortgage, the borrower signs the note, but the loan is secured only by the property. If the property sells for less than the loan balance, the lender cannot sue the borrower personally. This debt does not increase your at-risk amount.
• Liabilities you assume: If you buy a property already encumbered by a nonrecourse mortgage, the mortgage does not add to your at risk basis.
• Related-party recourse: If a family member or related party lends you money for the real estate, and their claim is truly nonrecourse (limited to the property), it does not count.

Why this matters for depreciation and losses

Most real estate investments generate paper losses early on. An income-producing property might throw off positive cash flow, yet the owner claims deductions for:

• Depreciation on the building and improvements (a non-cash deduction).
• Interest on the mortgage.
• Operating expenses (property taxes, insurance, maintenance, property management fees).

If a property generates £100,000 in depreciation but only £30,000 in cash losses, the at-risk rule does not directly prevent depreciation deductions; rather, it limits how much of the total losses can offset other income. Once your loss deduction exceeds your at-risk amount, the excess suspends until you contribute more capital or the venture generates gains.

Example

Suppose you purchase a commercial building for £1 million. You put down £100,000 in cash and finance the remaining £900,000 with a nonrecourse mortgage. In year one, the property generates £120,000 in depreciation and £20,000 in net operating losses. Your at-risk basis is £100,000 (your cash contribution). The at-risk rule allows you to claim only £100,000 of losses in that year; the remaining £40,000 suspends. In subsequent years, as you contribute additional capital or the venture generates gains, your at-risk basis increases, and previously suspended losses may be deducted.

The interplay with passive activity loss rules

The at-risk rules and the passive loss limitations work together but are separate. The at-risk rule is a ceiling: it says “you can’t deduct more than this.” The passive loss rule is a gate: it says “even if you are within the at-risk limit, you can’t use passive losses to offset active or portfolio income unless you meet certain tests.” A loss must clear both hurdles. For real estate professionals, the passive loss limitation may not apply, but the at-risk rules always do.

Real estate exceptions (and their limits)

Congress has long recognized that real estate differs from other businesses. In 1978, it carved out a separate at-risk provision for real estate investments, allowing certain nonrecourse financing to count toward at-risk basis—specifically, nonrecourse debt that is not convertible to recourse and is loaned by a lender unrelated to the borrower or certain equity investors. This exception makes real estate somewhat more favorable than other passive activities.

However, this relief is not unlimited. Qualified nonrecourse real estate financing can boost your at-risk basis, but only if it meets strict statutory criteria: the lender must be unrelated, the debt must be secured by real property, and it must not be convertible to recourse under the loan terms. Even then, it applies only to the specific real estate activity and does not let you sidestep the rule entirely.

Reporting and tracking

Taxpayers report at-risk activity on Form 6198, “At-Risk Limitations.” You must calculate your at-risk basis at the beginning of the year, track contributions and withdrawals, reduce basis by losses claimed, and report any suspended losses. For partners or S corporation shareholders in a real estate venture, the entity provides a schedule detailing each partner’s or shareholder’s at-risk basis so they can complete their own Forms 6198.

Why it persists

The at-risk rule is not as flashy as the passive loss limitation, but it is more fundamental. It prevents a scenario in which a speculator borrows £10 million against a property, claims £2 million in losses against other income, and—if the property appreciates—keeps the gain tax-free because the losses offset the income. The rule ensures that outside passive activity restrictions, you cannot have your losses and your gains too. You must have skin in the game.

See also