You can reduce income reported on your tax return by deducting allowable losses from a business or other for-profit activity. However the deduction is limited to the amount of money that you have at risk in the activity. In general, the at-risk amount is equal to the amount of money and adjusted basis of property that you contribute to the activity, plus any amounts you borrow for use in the activity for which you are personally liable to pay and the fair market value of property you pledged (other than property contributed to the activity) as security for the debt.
The at-risk amount generally doesn’t include any amounts for which you are guaranteed against loss through nonrecourse financing, or any other loss-limiting arrangement for which you are not personally liable.
The at-risk rules apply to:
Individuals (including partners and S corporation shareholders)
Estates and trusts
Certain closely held corporations (other than S corporations)
If some of the money you invested isn’t at risk, use Form 6198 to determine your allowable loss.
For more information on at-risk limitations and Form 6198, see IRS Publication 925.