Applying the Tax Basis and At Risk Rules to Partners by Karla Hopkins

Individuals who invest in partnerships need to be aware of rules that limit the ability of the partner to deduct losses. Individual partners who have been allocated a loss must satisfy three separate loss limitations before the loss can be used. The loss limitations, in the order in which they apply are, Tax Basis limitations, At Risk limitations, and Passive Loss limitations. Here we will address the first two.

A partner’s share of losses is limited to his Adjusted Tax Basis at the end of the year. In general terms, Basis includes money contributed, the adjusted basis of property contributed plus taxable income and tax exempt income allocated to him. These amounts are reduced by losses, nondeductible expenses and distributions allocated to him. A partner’s Basis is further adjusted by liabilities of the partnership that he is liable for. Losses that exceed the partner’s basis are suspended to a future year when Basis may be restored by future income or contributions to the partnership.

The second limitation is called At Risk. The amount At Risk includes the amount of money and adjusted basis of property contributed, amounts borrowed with respect to the activity to the extent the partner is personally liable or has pledged property as security for the debt and amounts borrowed by the partnership for holding real property for which no person is personally liable for repayment. The amount At Risk is also increased and decreased by the income and deductions of the partnership each year. Unlike basis, At Risk can go negative from items other than losses. The consequences of a negative At Risk amount are potential for recapture of previously deducted losses as income in the year the amount At Risk is negative.

When a partnership is initially funded with debt and incurs losses; the debt, while providing Tax Basis for deducting the losses, may limit the losses due to the At Risk rules. Losses suspended due to the At Risk rules may later become deductible in the year under the At Risk rules even when the Tax Basis has already been reduced.

When a partner’s Tax and At Risk Basis have been substantially diminished, losses allocated to the partner may not be deductible, and distributions to the partner may result in income recognition. These limitations are calculated each year and it is important for a shareholder to understand them and to maintain accurate and current records of their Basis. The partnership does not always provide the information to its shareholders. The calculation is especially important in the year that the partnership interest is terminated or sold.

A partner may avoid the Tax Basis and At Risk consequences by being aware of his tax basis and amount at risk and by taking measures to increase these amounts prior to the anticipated event.

The above is meant to be only a brief and general overview of the Tax Basis and AT Risk rules of partnerships. To calculate your basis requires a detailed evaluation of the partnership agreement and other relevant partnership elections.