8008 / May an individual’s amount at risk in an activity be less than zero (i.e., a negative amount)? If so, what are the tax effects of a negative amount at risk?

Although the amount of loss that is allowed as a deduction for the tax year cannot reduce a taxpayer’s amount at risk below zero, it is possible to have a negative amount at risk. For example, if a distribution exceeding the amount at risk by $100 is made to the taxpayer, the amount at risk is reduced to a negative $100. (A negative amount at risk may also result when a recourse obligation is changed to nonrecourse, or when a guarantee that relieves the taxpayer of personal liability for a debt goes into effect.)¹

If a taxpayer’s amount at risk falls below zero, he or she must recognize income to the extent the amount at risk is reduced below zero. An amount equal to the amount included in income is then carried over as a deduction with respect to the activity in the following tax year. In effect, the reduction (by distribution or other event) is treated as preceding the loss deductions previously taken that offset the original amount at risk, and the loss deduction in effect is treated as disallowed and carried over to a subsequent year. However, the amount required to be included in income when the at risk amount falls below zero cannot exceed the aggregate amount of reductions in the amount at risk that have taken place because of losses in prior years, reduced by any amounts included in income in prior years because the amount at risk had fallen below zero.²

1. See Prop. Treas. Reg. § 1.465-3.