Question

The at-risk limitation is basically the same as the tax basis limitation. Explain what this limitation is.

Answer 1

At risk limitation limits the amount of loss that an investor(say a limited partner in a partnership firm) can claim as a deduction to reduce the tax liability.

At risk limitation limits such deduction only to the amount that is actually at risk. That is the investment amount at risk.

If the investment has limited risk, then the amount of deduction will also be limited. For example, assume an individual invests $15,000 in a business that goes up in smoke after a couple of years. His risk in the investment, $15,000, can be recognised as a loss on his tax return. If the individual falls in the 24% ordinary income tax bracket at the federal level and 6% at the state level, then he can reduce his tax liability by (24% + 6%) x $15,000 = $4,500.

These rules are introduced to restrict the amount of deduction that a tax payer can avail to arrive at his tax liability.