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Sometimes it's not enough to be 'at-risk'

September 25, 2008

There are three hurdles to clear before you can deduct losses from a partnership. You have to clear them in this order:

1. You have to have basis in your partnership interest.
2. Your basis has to be "at-risk" basis.
3. The losses cannot be "passive."

A Court of Federal Claims Case Tuesday illustrated the last two hurdles. A group of taxpayers involved "in various partnerships marketed by the Greenberg Brothers" entered a closing agreement with the IRS on an at-risk issue:

Paragraph 6 of the Closing Agreement addresses the amount at risk under § 465, declaring that certain partnership liabilities were not amounts at risk for the partners, thus decreasing the amount of loss the partners might be able to claim for that year. But the agreement then permits losses disallowed under the Closing Agreement to be suspended consistent with § 465. That suspension meant, of course, the disallowed losses could be deducted in a future tax year if the partner/taxpayer were sufficiently at risk in that year.

Apparently the partners got at-risk basis in a later year and filed refund claims arising from the resulting tax losses. The IRS said, in effect, "fine, you crossed the 'at-risk' hurdle, but guess what? The losses are passive."

The partners sued, arguing that the terms of the closing agreement waived the passive loss rules. The judge was unpersuaded:

The passive loss restrictions have an entirely different aim from the at-risk rules -- namely, preventing taxpayers from using passive activity losses to offset income generated from non-passive activities. It is a stretch to assume that an agreement about the amount at risk is also an agreement on the entirely different topic of active versus passive losses, or that the words "any income" subvert the purpose of § 469 by allowing what that statute specifically prohibits.

The moral? Clearing the "at-risk" hurdle is necessary to deduct partnership losses, but it may not be sufficient.

Cite: Shelton, No. 02-1042 T (Ct. Claims, 9/23/2008)

Tags: at-risk rules.passive losses.