At-risk rules are laws that place limitations on the amount of losses that can be claimed on tax returns over a period of years. Rules of this type usually limit the cumulative loss to the total amount paid into an investment, while also limiting the claimed loss for each tax year to only that amount which was actually lost during the 12-month period. This arrangement makes it less likely that an individual or business would be able to claim a loss that is greater than the actual investment in a currently owned asset.
An easy way to understand how at-risk rules function is to consider an investor who purchases an asset for an amount of $50,000 US dollars (USD). Rather than netting some sort of increase for that investor, the asset generates losses that amount to $10,000 USD the first two years of ownership and losses of $15,000 for the next three years of ownership. While the total losses over that five-year period amount to $65,000 USD, the investor can only claim up to the amount that is actually invested in that asset, meaning that claiming a loss can only occur for the first four of the five years. Unless the investor has put additional funds into the investment at some point, there is no ability to claim additional losses during that fifth year and gain some sort of tax break.
Use of the at-risk rules can occur with just about any type of investment or asset. Individuals and businesses that purchase real estate as investments can usually make use of the rules to claim losses on properties up to the amount they have actually invested in those properties. Investments in other types of assets that may depreciate over time may also be subject to the at-risk rules. Essentially, if an investor incurs a loss on one or more assets, it is possible to claim that actual loss up to the total amount invested.
The imposition of at-risk rules helps to limit the amount of losses that can be claimed in any single tax year. In nations that include these types of rules in tax regulations, the rules help to prevent situations in which taxpayers can manipulate returns so that losses are claimed that have not yet occurred. A tax professional can evaluate any assets that have incurred a loss during the current tax year, determine if claiming that loss is possible, and help taxpayers to avoid claiming a loss that is in violation of the at-risk rules.
