1040-US: Loss limitation calculations

Alerts and notices


How do loss limitations calculate?


There are three separate potential limitations on the amount of losses that may be deducted. These limitations and the order in which they apply are:

  • The basis rules (pass-through entities only)
  • The at-risk limitations
  • The passive activity limitations
  • The Section 461 business loss limitation

Losses passed through from partnerships and Subchapter S Corporations are only allowed to the extent the taxpayer has basis in the pass-through activity. Basis in a partnership is basically the money and any adjusted basis of property contributed as well as changes in the partner's individual liabilities. Basis is increased by additional contributions (including increased share of partnership liabilities) and partner's share of taxable and nontaxable income. S Corporation losses are limited to the taxpayer's stock basis and loans from the taxpayer to the S Corporation. Stock basis is generally increased by all income reported on Schedule K-1 (1120S) and decreased by property distributions.

At-risk rules apply to any activity operating as a trade or business, or for production of income. When a partner or shareholder is completely at-risk in the basis of the entity, Form 6198 is not required. Losses are only allowed to the extent of the taxpayer's actual financial risk from the activity. The amount of losses that exceed the at-risk amount are not deductible. For purposes of applying at-risk limits, the loss from an activity is defined as the excess of deductions over income. Therefore, even if a taxpayer has no amount at-risk, a deduction is allowed to the extent of income from the activity. A taxpayer's amount at-risk is not identical to the adjusted basis in an activity. Certain items are treated differently under at-risk rules than under basis rules.

The application calculates and tracks losses based on basis, at-risk, and passive activity rules. The application provides a worksheet for each limitation to track allowed and disallowed losses that would generate carryovers for next year.

After all the above limitations, the limitation on business losses is calculated on Form 461. The overall loss limited on Form 461 is entered as a positive amount on Form 1040, Schedule 1, Line 21 - Other income. Losses limited on the return become part of the net operating loss carryforward.

Related topic: Form 6198 - At-risk calculations FAQs (1040)

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