IRS Form 6198

Owning a business can create opportunities to deduct legitimate business losses and reduce taxable income. However, the IRS does not allow every business owner to deduct every reported loss immediately. One important limitation is known as the at-risk rule, which generally limits deductible losses to the amount a taxpayer has financially at risk in a business or investment activity.

IRS Form 6198, At-Risk Limitations, helps determine how much of a business loss may be deductible in the current tax year. These rules can affect sole proprietors, farmers, real estate investors, partners, and S corporation shareholders.

For small-business owners in Grand Rapids, Kentwood, Wyoming, and throughout West Michigan, understanding Form 6198 can help prevent tax-return errors and improve business tax planning.

What Is IRS Form 6198?

Form 6198 is used to calculate the profit or loss from an activity, determine the taxpayer’s amount at risk, and establish the portion of a loss that may be deducted under the at-risk rules.

The basic principle is straightforward: a taxpayer generally cannot deduct a loss beyond the amount the taxpayer is financially at risk of losing in the activity.

For example, a business owner may report a substantial loss on a business tax return. However, if some of the investment was funded through financing for which the owner has no personal economic exposure, the full loss may not be deductible under the at-risk rules.

The form helps separate the business’s reported loss from the amount currently allowable under these limitations.

The IRS explains the form and its requirements in the official Form 6198 instructions.

Who May Need to File Form 6198?

Form 6198 may be required for individuals, estates, trusts, and certain closely held C corporations.

Individuals who report business or investment activity on Schedule C, Schedule E, or Schedule F may need to consider the form. It can also affect partners and S corporation shareholders who receive business income, deductions, or losses through Schedule K-1.

Generally, Form 6198 is required when the taxpayer or a relevant pass-through business has amounts invested in an at-risk activity that are not considered at risk and the activity incurs a loss. Special filing rules also apply to certain activities and borrowing arrangements.

Examples of taxpayers who may need to review the form include:

• Sole proprietors: Business owners who report income and expenses on Schedule C.
• Farmers: Individuals who report qualifying farm income and expenses on Schedule F.
• Real estate investors: Taxpayers whose activities involve property subject to the at-risk rules.
• Partnership investors: Partners who receive allocated losses through Schedule K-1.
• S corporation shareholders: Owners who receive business losses through Schedule K-1.
• Other business investors: Taxpayers whose investments involve financing arrangements that may limit the amount considered at risk.

Not every business loss requires Form 6198. The filing requirement depends on the activity, financing, losses, and applicable exceptions.

What Does It Mean to Be Financially at Risk?

The at-risk rules focus on how much money or property a taxpayer could genuinely lose if the business or investment fails.

Amounts generally considered at risk can include:

• Cash invested in the activity.
• The adjusted tax basis of qualifying property contributed.
• Certain borrowed amounts for which the taxpayer is personally liable.
• Certain qualified nonrecourse financing secured by real property used in an eligible real-property activity.
• Other amounts that meet the requirements of the tax law.

The rules distinguish between genuine financial exposure and arrangements that protect a taxpayer against economic loss.

For example, suppose a business owner invests $50,000 of personal money in a qualifying business. If the investment is fully exposed to the risk of business failure, that amount may generally contribute to the owner’s amount at risk.

Now suppose another investor contributes $50,000 but the investment is protected by an arrangement guaranteeing that the investor will recover the money regardless of the business’s performance. Depending on the arrangement, the protected amount may not qualify as at-risk investment.

The actual calculation depends on the legal and financial details.

How Do Nonrecourse Loans Affect Form 6198?

Nonrecourse loans are an important consideration under the at-risk rules.

A nonrecourse loan generally means the borrower is not personally liable for repayment beyond the property or collateral securing the loan. In many circumstances, borrowed money that is not personally at risk cannot be included in the taxpayer’s amount at risk.

For example, an investor may finance a business asset with a loan secured only by the asset itself. If the lender cannot pursue the investor personally for a deficiency, the financing may not increase the investor’s at-risk amount.

However, there are exceptions. Certain qualified nonrecourse financing secured by real property used in an eligible activity of holding real property may count as an amount at risk.

This exception has specific requirements and should not be applied automatically to every real estate loan.

The important distinction is that not every dollar borrowed to fund a business increases the taxpayer’s deductible-loss capacity.

How Does Form 6198 Limit Business Losses?

Consider a simplified example.

A small-business owner reports a $60,000 loss from an activity. After reviewing the investment, qualifying liabilities, and other adjustments, the owner’s amount at risk is only $25,000.

The at-risk rules may limit the current deduction to $25,000. The remaining $35,000 generally cannot be deducted in the current year under these rules.

The suspended amount may generally be carried forward and potentially deducted in a later year when the taxpayer’s amount at risk increases, subject to the applicable rules and other limitations.

This is only an illustration. The actual result depends on the taxpayer’s income, expenses, basis, financing, and the type of activity involved.

Also, passing the at-risk test does not automatically make a loss deductible. Other restrictions may apply.

How Are the At-Risk Rules Different From the Basis and Passive Activity Rules?

Business owners may encounter several loss limitations that operate separately.

1. Basis limitations

For partnerships and S corporations, basis rules generally determine whether the owner has sufficient tax basis to deduct a passed-through loss. For example, S corporation shareholders may need Form 7203 to calculate stock and debt basis.

2. At-risk limitations

The at-risk rules generally limit deductions to the amount the taxpayer is economically at risk of losing in the activity. Form 6198 is used to calculate this limitation when required.

3. Passive activity loss limitations

Passive activity rules can further restrict losses from activities in which the taxpayer does not materially participate, subject to exceptions.

These limitations generally apply in a required sequence. A loss may pass one test but still be limited by another.

For example, an S corporation shareholder may have sufficient stock basis to absorb a loss, but the at-risk rules may still limit the deduction. Even if the loss passes both tests, passive activity restrictions may apply.

Understanding the distinction can help avoid claiming deductions that are not currently allowed.

What Happens to Losses That Cannot Be Deducted?

Losses disallowed under the at-risk rules are generally carried forward and may become deductible in a later year when the taxpayer’s amount at risk increases sufficiently.

Amounts at risk can change over time. Additional qualifying capital contributions, certain qualifying loans, income from the activity, and other permitted adjustments may increase the amount at risk. Distributions, withdrawals, and certain changes in liabilities may decrease it.

Taxpayers should maintain records of suspended losses from previous years. Those amounts should not simply be forgotten or deducted automatically in the next tax year.

The taxpayer must determine whether the limitation has been resolved and whether other deduction restrictions still apply.

Common Form 6198 Mistakes to Avoid

Business owners and investors should watch for these common errors:

1. Assuming all reported losses are deductible. The business’s tax loss and the allowable deduction may differ.
2. Counting all loans as amounts at risk. Nonrecourse financing and protected investments require careful review.
3. Confusing basis with at-risk amount. These are separate tax calculations.
4. Forgetting suspended losses. Prior-year disallowed losses need to be tracked and reviewed.
5. Ignoring other loss limitations. Basis, at-risk, passive activity, and other restrictions may apply.
6. Failing to document financing arrangements. Loan agreements, guarantees, collateral, and repayment obligations may affect the calculation.
7. Assuming the rules are identical for every business. Different activities and ownership structures can have different requirements.

How AIM Financial Can Help With Business Loss Deductions

Business tax preparation involves more than adding up income and expenses. Owners may need to consider financing arrangements, tax basis, business losses, shareholder loans, and restrictions on deductions.

AIM Financial provides tax preparation assistance for individuals and businesses in Grand Rapids, Kentwood, Wyoming, and throughout West Michigan. If you operate a small business, own an S corporation, invest through a partnership, or have business losses that may be limited, professional tax preparation can help you understand the applicable reporting requirements.

AIM Financial can help you organize business records, review questions about deductible losses, and identify which tax forms may be required. Keeping accurate records of contributions, loans, distributions, and suspended losses can make future tax returns easier to prepare.

Contact AIM Financial for Tax Preparation Help

If you have a business loss and are unsure how much you can deduct, do not assume that the amount shown on your business records is automatically deductible on your federal income tax return.

Contact AIM Financial for tax preparation assistance in Grand Rapids, Kentwood, Wyoming, and throughout West Michigan.

For official guidance, visit IRS.gov/Form6198 and review the instructions for the tax year you are filing.

This article provides general educational information and is not individualized tax advice.

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AIM Financial explains IRS Form 6198 and at-risk rules that can limit business loss deductions for West Michigan taxpayers.

Official IRS resources

• About Form 6198 Internal Revenue Service
• Instructions for Form 6198 Internal Revenue Service
• Publication 925: Passive Activity and At-Risk Rules Internal Revenue Service

Suggested next unique blog: IRS Form 8582 Explained: Passive Activity Loss Limitations and Why Rental Property Losses May Be Suspended.