What does the at-risk rule limit?

The at-risk rule specifically limits the amount of loss that a taxpayer can deduct from passive activities to the amount they actually have at risk in the investment. This means that if a taxpayer has invested in a passive activity, such as a limited partnership or rental property, they can only deduct losses up to the amount they are personally liable for or have invested, without any consideration for non-recourse loans or other funding sources that do not expose them to risk of loss.

By this limitation, the Internal Revenue Code helps prevent taxpayers from claiming excessive losses that exceed their actual economic investment in the activity. This is particularly important in tax law, as it helps ensure that taxpayers cannot undermine tax revenue through undue deductions based on investments that they do not personally support financially.

In contrast, while capital gains, business expenses, and tax credits are all important components of tax regulation, they are not governed by the at-risk rule, which uniquely addresses the deductibility of losses from passive investments.