At-Risk Recapture: Triggers, Carryforwards, and Form 6198

At-risk recapture is the rule that forces you to report previously deducted losses as ordinary income when your at-risk amount in an activity falls below zero at the end of a tax year. Under Section 465(e) of the Internal Revenue Code, the negative balance is added back to your gross income, reversing the tax benefit you claimed in earlier years.¹ The recaptured amount then carries forward as a deduction you can use in a later year once your at-risk balance recovers. So the hit is real in cash-flow terms, but in most cases it’s a timing event rather than a permanent tax increase.

What Triggers At-Risk Recapture

Recapture kicks in when your at-risk amount in an activity drops below zero as of the close of the tax year. Two patterns cause this more than any others.

The first is distributions that outrun your basis. In partnerships and S corporations, cash often flows out to owners before the activity produces enough taxable income to support those withdrawals. Each distribution chips away at your at-risk balance, and a large enough one pushes it negative.

The second is debt restructuring. If a loan you personally guaranteed is converted to nonrecourse financing, you are no longer on the hook for repayment, and that reduction in personal liability can drag your at-risk amount below zero on its own. The same thing happens when a guarantee, stop-loss agreement, or indemnity that protects you from loss is put in place after you have already taken deductions. Changes in your share of partnership liabilities can also shift the balance, particularly when partnership agreements are amended or new partners join and dilute your share of recourse debt.¹

Who this applies to: individuals and closely held C corporations, plus partners and S corporation shareholders at the individual level. Widely held C corporations are outside the at-risk rules.¹

How Much Gets Recaptured

The recaptured amount is not the full negative balance measured in isolation. It is capped at the total prior losses from the activity that reduced your at-risk amount. You only give back what you actually took.

The recaptured amount is included in your gross income and treated as income from the activity, so it is taxed at ordinary income rates rather than as capital gain.¹ For 2026, federal ordinary income rates run from 10 percent up to 37 percent depending on total taxable income.² A taxpayer sitting comfortably in the 24 percent bracket can find an unexpected recapture bump pushing part of their income into the 32 percent bracket.

The Carryforward Deduction

The recaptured amount is not gone. It automatically becomes a deduction allocated to the same activity for the following tax year.¹ You can use that deduction once your at-risk amount grows again, whether by contributing more cash, taking on new recourse debt, or earning income from the activity. Until then, it sits parked.

In practice this means recapture usually creates a timing mismatch rather than a permanent tax cost. But the cash-flow pain in the recapture year is real, especially if the trigger was a paper event like a loan restructuring rather than an actual distribution of cash you can use to pay the tax.

What Actually Sits in the At-Risk Balance

To see why a balance moved and whether it can be rebuilt, you need to know what goes in it. Section 465(b) sets the components.¹

Cash you put into the activity counts dollar for dollar.
Property you contribute counts at its adjusted basis (original cost minus depreciation and other prior adjustments).
Amounts you borrow for the activity count when you are personally liable for repayment, so the lender can reach your personal assets if the activity fails.
Loans from someone whose only connection to the activity is as a creditor can count; loans from someone with an ownership stake generally do not.

The balance rises when the activity generates income and falls when you claim deductions or receive distributions. It’s a running figure that shifts every year.

The Real Estate Exception for Nonrecourse Debt

Real estate gets a carve-out no other activity enjoys. Qualified nonrecourse financing counts toward your at-risk amount even though no one is personally on the hook. The loan must be used for holding real property, come from a qualified lender (such as a bank, savings institution, or a federal, state, or local government entity), have no person personally liable for repayment, and not be convertible into an ownership interest.¹ The financing must also be secured by the real property used in the activity. Commercially reasonable loans from related parties can qualify if the terms are substantially the same as an unrelated lender would offer.

What Doesn’t Count

If a guarantee, stop-loss agreement, nonrecourse financing outside the real estate exception, insurance, or any similar arrangement shields you from economic loss, the protected amount is excluded from your at-risk total. Section 465(b)(4) is drafted broadly on purpose: if you can’t actually lose the money, you shouldn’t be deducting losses against it.³

Loans from someone with an ownership stake in the activity (other than as a pure creditor) do not increase your at-risk amount, and neither do loans from persons related to such an owner. The at-risk rules use a 10 percent ownership threshold to define related persons, where other Code provisions typically use 50 percent.³ That low bar catches a lot of family and close-partner lending that would pass under other tests.

Where At-Risk Sits Among Loss Limitations

The at-risk rules don’t operate alone. Federal tax law stacks several loss-limitation systems, and the order they apply in changes the result. Losses are tested in this sequence:⁴

Basis limitations. Your deductible loss cannot exceed your adjusted basis in the partnership interest or S corporation stock, plus any loans you have made to an S corporation.
At-risk limitations. Losses that survive the basis test are capped at your at-risk amount, reported on Form 6198.
Passive activity loss limitations. Losses that clear the at-risk hurdle may still be suspended if the activity is passive, reported on Form 8582.
Excess business loss limitation. Any remaining deductible loss is subject to a cap on total business losses, reported on Form 461.

A loss blocked at an earlier stage never reaches the later ones. If the at-risk rules stop a $50,000 loss, that amount is not treated as a passive activity deduction for the year and doesn’t enter the passive loss calculation at all.⁴ It stays suspended under the at-risk rules and carries forward there.

Reporting on Form 6198

Form 6198 is where the IRS tracks your at-risk position year to year. You must file it if you are an individual, estate, trust, or closely held C corporation that had amounts not at risk invested in a loss-generating activity during the tax year, or if you are engaged in a general trade or business activity and have borrowed amounts from persons with an interest in the activity.⁵

The form has four parts. Part I calculates the current-year profit or loss from the activity. Part II provides a simplified method for computing your at-risk amount. Part III offers a more detailed calculation that may produce a larger at-risk figure. Part IV determines your actual deductible loss. When your at-risk amount has gone negative, the instructions direct you to Publication 925 for the recapture income calculation.⁵

Attach the completed Form 6198 to your annual return under the standard filing deadline. Keep records of every contribution, distribution, debt assumption, and restructuring that affected the balance, because reconstructing these figures during a later audit is much harder than logging them as they happen.

Penalties for Getting It Wrong

Failing to report recapture income, or inflating your at-risk amount, can trigger the accuracy-related penalty under Section 6662. The penalty is 20 percent of the underpayment caused by negligence or a substantial understatement of income tax.⁶ A substantial understatement exists when the understated amount exceeds the greater of 10 percent of the tax that should have been shown on the return or $5,000. For corporations other than S corporations, the threshold is the lesser of 10 percent of the correct tax (or $10,000 if greater) and $10 million.

The IRS treats failure to apply the at-risk rules as negligence when the taxpayer didn’t make a reasonable attempt to comply. Given that Form 6198 exists specifically for this calculation and the instructions walk through it step by step, ignorance is a hard argument. The 20 percent penalty stacks on top of the tax owed on the recaptured income, plus interest running from the original due date.

1
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
2
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
3
Office of the Law Revision Counsel. 26 US Code 465 – Deductions Limited to Amount at Risk
4
Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
5
Internal Revenue Service. Instructions for Form 6198
6
Office of the Law Revision Counsel. 26 US Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments