19.7 At-Risk & Passive Activity Rules
Key Takeaways
- Partners can only deduct losses to extent they are 'at risk.'
- At-risk includes cash, property basis, and recourse debt.
- Passive losses can only offset passive income (§469 unchanged).
- $25,000 rental real estate exception for active participants (phase-out $100K-$150K AGI).
- Material participation requires 500+ hours or other tests.
- Excess Business Loss limits 2025: $313,000 Single / $626,000 MFJ — made PERMANENT by OBBBA.
Why This Matters for the Exam
Loss limitations are heavily tested. The exam tests at-risk amounts, passive activity rules, and the rental real estate exception.
Expect at least 3-4 questions on loss limitations.
Loss Limitation Hierarchy
Losses face four sequential hurdles:
| Order | Limitation | Rule |
|---|---|---|
| 1 | Basis | Cannot exceed outside basis (§704(d)) |
| 2 | At-Risk | Cannot exceed at-risk amount (§465) |
| 3 | Passive Activity | Cannot offset active/portfolio income (§469) |
| 4 | Excess Business Loss | Limited at individual level (§461(l)) |
NEW: Excess Business Loss (§461(l)) — Permanent post-OBBBA
For Tax Year 2025, the aggregate active-business loss an individual can deduct against non-business income is capped:
| Filing Status | 2025 EBL Limit |
|---|---|
| Single / HoH / MFS | $313,000 |
| MFJ / QSS | $626,000 |
Losses exceeding the limit are carried forward as an NOL (subject to the 80% taxable-income limit). OBBBA made §461(l) permanent (it had been scheduled to sunset after 2028).
At-Risk Rules
Partners can only deduct losses to extent they are at risk.
| Included in At-Risk | Not Included |
|---|---|
| Cash contributions | Nonrecourse debt |
| Property basis contributed | Stop-loss arrangements |
| Recourse debt (personally liable) | Guaranteed returns |
| Income allocated | Protection from loss |
At-Risk Example
| Item | Amount |
|---|---|
| Cash contributed | $20,000 |
| Share of nonrecourse debt | $50,000 |
| At-risk amount | $20,000 |
| Deductible loss limit | $20,000 |
Passive Activity Basics
| Income Category | Description |
|---|---|
| Active | Wages, SE income, material participation business |
| Passive | Rental, business without material participation |
| Portfolio | Interest, dividends, capital gains |
Rule: Passive losses can ONLY offset passive income.
Material Participation Tests
A partner materially participates if they meet any of seven tests:
| Test | Requirement |
|---|---|
| 1 | 500+ hours during year |
| 2 | Substantially all participation |
| 3 | 100+ hours, more than anyone else |
| 4 | Significant participation (aggregate 500+) |
| 5 | Materially participated 5 of last 10 years |
| 6 | Personal service activity—3 prior years |
| 7 | Facts and circumstances regular, continuous |
$25,000 Rental Real Estate Exception
Active participants (lower standard) can deduct up to $25,000 of rental losses:
| Requirement | Detail |
|---|---|
| Active participation | Management decisions (approve tenants, set rent) |
| Ownership | At least 10% |
| AGI limit | Phase-out $100,000-$150,000 |
Phase-Out Calculation
| AGI | Calculation | Allowance |
|---|---|---|
| ≤$100,000 | Full | $25,000 |
| $120,000 | $25,000 - ($20,000 × 50%) | $15,000 |
| $140,000 | $25,000 - ($40,000 × 50%) | $5,000 |
| ≥$150,000 | Fully phased out | $0 |
Real-World Scenario
Scenario: Partner contributes $20,000 cash. Partnership has $100,000 nonrecourse debt. Partner's share of loss is $50,000. Partner is a passive investor.
- Basis limit: $20,000 + share of debt = varies.
- At-risk limit: $20,000 (nonrecourse not included).
- Deductible: $20,000 maximum.
- Suspended: $30,000 (at-risk limitation).
On the Exam
Expect 3-4 questions on loss limitations, typically:
- At-Risk Questions: "What is the at-risk amount?"
- Passive Questions: "Can passive losses offset wages?"
- Rental Exception Questions: "What is the maximum rental loss deduction for AGI of $X?"
The key is to remember: At-risk = cash + recourse debt (not nonrecourse). Passive losses offset passive income only. Rental exception = $25,000, phase-out $100k-$150k.
Partner contributes $20,000 cash. Partnership has $100,000 nonrecourse debt. At-risk amount?
Taxpayer with $80,000 AGI actively participates in rental with $20,000 loss. How much deductible against active income?
Taxpayer with $130,000 AGI. Maximum rental real estate loss allowance?