7905. Under the at risk rules, how is an individual’s “amount at risk” determined?Nuco Employeercline202014-07-07T22:31:00Z2014-07-07T22:31:00Z515598890Summit Business Media74201042914Site Map/Investments/Special Rules/Limitation on Loss Deductions/At RiskTaxFactsDefaultArticle123171287-00-tf2.xml1287.00;#1956;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2UNder the at risk rule, how is an individual’s “amount at risk” determined?41200.0000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-14T22:56:06Z7905. 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).Prop. Treas. Reg. §1.465-6. A partner’s “amount at risk” is not affected by a loan made to the partnership by any other partner.Prop. Treas. Reg. §1.465-7. Payment by a purchaser to the seller for an interest in an activity is treated by the purchaser as a contribution to the activity.Prop. Treas. Reg. §1.465-22(d).More specifically, an individual has “at risk” in an activity an amount equal to the total of:IRC Sec. 465(b).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.Treas. Reg. §1.465-20; Prop. Treas. Regs. §§1.465-6, 1.465-25.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.Prop. Treas. Reg. §1.465-22(a).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.See Prop. Treas. Reg. §1.465-23.3. 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.See Let. Rul. 7927007. The 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.Pritchett v. Comm., 827 F.2d 644, 87-2 USTC ¶9517 (9th Cir. 1987). 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.Prop. Treas. Reg. §1.465-5. See Rev. Rul. 82-123, 1982-1 CB 82; Rev. Rul. 81-283, 1981-2 CB 115. 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).See Prop. Treas. Reg. §1.465-24(b).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.Prop. Treas. Reg. §1.465-25(a). 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.IRC Sec. 465(b)(2). 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 basisAs defined in Prop. Reg. 1.465-23(b)(1) of such assets.Treas. Reg. §1.465-22(c)(1). 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.IRC Sec. 465(b)(3).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).IRC Secs. 465(b)(3)(C), 267(b), 707(b)(1).Amounts borrowed from family members or other persons related to the taxpayer may be considered at risk under certain limited circumstances.IRC Sec. 465(b)(3). See General Explanation–TRA ’84, pp. 735-736.An individual is not considered “at risk” with respect to any amount that is protected against loss through guarantees, stop loss agreements, nonrecourse financing (other than qualified nonrecourse financing of real estate described in (5), below), or other similar arrangements.IRC Sec. 465(b)(4). See S. Rep. 938, 94th Cong., 2d Sess. 49, reprinted in 1976-3 CB (vol. 3) 57 at 87. See Rev. Rul. 78-413, 1978-2 CB 167; Rev. Rul. 79-432, 1979-2 CB 289. An investor is not at risk with respect to a note that may be satisfied by transferring to the creditor property that is derived from the activity if there is no obligation on the part of the investor-borrower to pay the difference should the value of the property transferred be less than the amount of the note.Rev. Rul. 85-113, 1985-2 CB 150.5. Qualified nonrecourse financing with respect to the activity of holding real property. An investor in real estate (excluding mineral property) is considered at risk with respect to nonrecourse financing if:(a)no person is personally liable for repayment (except to the extent provided in regulations),(b)the financing is secured by real property used in the activity,(c)the financing is borrowed with respect to the activity of holding real property,(d)the financing is not convertible debt, and either (1) the financing is borrowed from a “qualified person” or represents a loan from any federal, state, or local government or instrumentality thereof, or is guaranteed by any federal, state, or local government, or (2) the financing is borrowed from a related person upon commercially reasonable terms that are substantially the same terms as loans involving unrelated persons.IRC Sec. 465(b)(6).A “qualified person” is one who is actively and regularly engaged in the business of lending money and who is not (1) related in certain ways to the investor, (2) the one from whom the taxpayer acquired the property (or related to such a person), or (3) a person who receives a fee with respect to the lessor’s investment in the real estate (or related to such a person).IRC Secs. 465(b)(6)(D)(i), 49(a)(1)(D)(iv). In the case of a partnership, a partner’s share of qualified nonrecourse financing of the partnership is determined on the basis of the partner’s share of such liabilities incurred in connection with such financing.IRC Sec. 465(b)(6)(C).In any case, if a taxpayer engages in a pattern of conduct or utilizes a device that is not within normal business practice or that has the effect of avoiding the “at risk” limitations, the taxpayer’s amount at risk may be adjusted to more accurately reflect the amount that is actually at risk. For example, if considering all the facts and circumstances, it appears that an event that results in an increased amount at risk at the close of one year will be accompanied by an event that will decrease the amount at risk after the year ends, these amounts may be disregarded, unless the taxpayer can establish a valid business purpose for the events and establish that the resulting increases and decreases are not a device for avoiding the at risk limitations in the earlier year.Prop. Treas. Reg. §1.465-4. The facts and circumstances to be considered include: (1) The length of time between the increase and decrease in the amount at risk; (2) The nature of the activity and deviations from normal business practice in the conduct of that activity; (3)The use of those amounts which increased the amount at risk toward the close of the taxable year; (4) Contractual arrangements between parties to the activity; and (5)The occurrence of unanticipated events which make the decrease in the amount at risk necessary.Prop. Treas. Reg. §1.465-4(a), Notice 2002-50, 2002-2 CB 98. A partner’s amount at risk is increased by the amount of the partner’s share of undistributed partnership income and his or her share of any tax-exempt proceeds.Prop. Treas. Reg. §1.465-22(c)(1). It is reduced by distributions of taxable income and by losses deducted.Prop. Treas. Regs. §§1.465-22(b), 1.465-22(c)(2). It is also reduced by nondeductible expenses relating to production of tax-exempt income of the activity.Prop. Treas. Reg. §1.465-22(c)(2).