Identifying corporations subject to the atrisk rules.

• Author: Hackett, Trenda

The Sec. 465 at-risk rules are intended to prevent taxpayers from deducting losses in tax shelters and similar activities in excess of the actual amount of money they might lose if the activity was abandoned. The rules have no effect on profitable activities. These rules limit the losses allowed to certain closely held C corporations on investments in certain activities (Sec. 465(a)(1)).

For purposes of the at-risk rules, a closely held C corporation is a corporation in which five or fewer individuals own (directly or indirectly) at any time during the last half of the tax year more than 50% in value of the stock. For this purpose, a personal service corporation can be a closely held corporation.

The at-risk rules cover losses in farming; oil, gas, and geothermal exploration; equipment leasing; movie or videotape holding, production, and distribution; and all trade or business activities or activities for the production of income not already specified (Secs. 465(c)(1) and (3)). A corporation is considered at risk in an activity to the extent of: (1) cash contributed to the activity; (2) the adjusted basis of other property contributed; (3) amounts borrowed for use in the activity if the corporation is liable for repayment; and (4) amounts borrowed for use in the activity to the extent the corporation has pledged property other than property used in the activity as security for the borrowed amount (to the extent of the net fair market value of the corporation's interest) (Sec. 465(b)). The amount of loss a corporation may recognize from an activity is limited to the amount that is at risk for that activity at the close of the tax year (Sec. 465(a)(1)).

When applying the rules to amounts borrowed, one of the more difficult issues involves contingent or deferred obligations. Clearly, the mere guarantee by an investor of another's debt does not increase the amount at risk (Prop. Regs. Sec. 1.465-6(d)). But the extent to which contingent liabilities and deferred obligations increase the amount at risk is less clear. Prop. Regs. Sec. 1.465-6(c) states that when the taxpayer is liable for repayment based only on the occurrence of a contingency, the taxpayer is considered at risk if the likelihood of the contingency occurring is such that the taxpayer is not effectively protected against loss or if the protection does not cover all likely possibilities.

Example 1. At-risk amount based on contingent liability: M Corp., a closely held corporation, is...