What Is Form 6198, At-Risk Limitations?
Understand how at-risk rules determine your deductible loss. This guide explains how Form 6198 aligns your tax deduction with your personal financial stake.
IRS Form 6198, “At-Risk Limitations,” is a tax document used to enforce a principle of federal tax law. It limits the amount of loss a taxpayer can deduct from an investment or business activity to the amount they are personally financially exposed to in that venture. This prevents individuals and certain corporations from claiming deductions for losses that exceed their actual economic stake, ensuring deductions align with the taxpayer’s true investment risk.
Determining if You Need to File
A taxpayer must file Form 6198 only when they have incurred a loss from an activity subject to the at-risk rules. If the activity generates a profit, this form is not necessary. The at-risk rules apply to most activities conducted as a trade or business or for the production of income.
These rules specifically cover:
- Farming
- Exploring for oil and gas resources
- Exploring for or exploiting geothermal deposits
- Holding mineral property
- Leasing certain types of property
- Holding, producing, or distributing motion picture films or videotapes
Beyond these industries, the at-risk limitations apply to nearly any other business or income-producing activity. Individuals, partners in a partnership, or shareholders in an S corporation with a loss for the year must evaluate if they need to file Form 6198, which is filed with the main tax return.
Calculating Your Amount at Risk
You must calculate your “amount at risk” for the specific activity, which represents your financial stake at the close of the tax year. The calculation begins with the cash you have personally contributed and the adjusted basis of any property you have contributed.
Your at-risk amount is also increased by certain borrowed funds for which you are personally liable for repayment. This means that if the business cannot pay the debt, the lender can seek repayment from your personal assets.
An exception exists for real estate activities involving “qualified nonrecourse financing.” Generally, you are not at risk for nonrecourse loans, where the lender’s only recourse is the property itself. However, for real estate, qualified nonrecourse financing from a commercial lender is treated as an amount at risk if it is secured by the real property.
Items that decrease your at-risk amount include any money or property you withdraw from the activity. Your at-risk basis is also reduced by any losses from the activity that were allowed as deductions in previous tax years. This amount must be adjusted annually to reflect the year’s financial activities.
Completing and Filing Form 6198
When filling out Form 6198, you will report your total loss from the activity. This may include suspended losses from prior years that were disallowed by these same at-risk rules.
The form compares your total loss for the year to your calculated amount at risk. The smaller of these two figures is your deductible loss for the current year. This final deductible loss figure is then carried to the appropriate schedule, such as Schedule C for a sole proprietorship, Schedule E for rental or partnership income, or Schedule F for farming.
Any portion of the loss that is greater than your at-risk amount is disallowed for the current year. This disallowed loss is not permanently lost but is carried forward to the next tax year. In a future year, if you increase your amount at risk in the same activity, you may be able to deduct the suspended loss.