IRS Releases Favorable Guidance on the "At-Risk" Rules, but Risks Remain
Timothy M. Nichols
In addition to the passive activity loss rules and basis limitations on loss deduction, the “at-risk” rules impose a separate set of requirements for taxpayers desiring to take tax losses. In the Chief Counsel Advice described below, the IRS issued helpful clarification regarding one aspect of the at-risk rules. However, the IRS also highlighted a potential at-risk rule issue for related entities that taxpayers may not appreciate.
Chief Counsel Advice 201308028 (“CCA 2013”)
The at-risk rules codified in § 465 of Internal Revenue Code and the related regulations are generally intended to limit a taxpayer's ability to deduct losses from an activity to the taxpayer's amount “at risk” in the activity. In CCA 2013, the IRS addressed a common situation where a bank loan to a taxpayer's limited liability company (“LLC”) is guaranteed by the taxpayer. In the most basic scenario, the taxpayer is the only member of the LLC and guarantees the entire amount of the bank loan. Intuitively, the taxpayer should be considered “at risk” for this loan, as the taxpayer bears the ultimate risk of default through his or her guarantee.
However, Prop. Reg. § 1.465-6(d) states that if “a taxpayer guarantees repayment of an amount borrowed by another person (primary obligor) for use in an activity, the guarantee shall not increase the taxpayer's amount at risk.” IRS agents have apparently argued that this proposed regulation prevents the taxpayer's guarantee of a bank loan to the LLC from increasing the taxpayer's amount at risk. In CCA 2013, the IRS appropriately limited the application of Prop. Reg. § 1.465-6(d) to the limited partner context, where the guarantee of a partnership liability by a limited partner could be offset by a right of recovery against a general partner. CCA 2013 indicates that this proposed regulation generally was not applicable to a guarantee by an LLC member of an LLC’s debt, as the guarantor generally does not have a right of recovery against a third party.
Nevertheless, CCA 2013 highlights an additional issue with the at-risk rules that may impact taxpayers who own more than one entity. In CCA 2013, the loan to the LLC was guaranteed not only by the taxpayer but also by two corporations wholly owned by the taxpayer. The IRS held that the guarantees by the two wholly owned corporations could reduce the taxpayer's amount at risk with respect to the activity of the LLC, because the taxpayer may have a right of contribution or reimbursement against those corporations. This result may be a surprise to some taxpayers, who would not view a guarantee by a wholly owned entity as reducing their amount at risk. However, while this result may seem unfair, it can often be avoided with appropriate tax planning by a tax advisor well versed in the at-risk rules and other tax loss limitations.
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