Before the IRS applies the passive activity rules, it first limits your deductions to the amount you have at risk (per Section 465). Any losses above your at-risk amount are suspended and carried forward.
What counts as "at risk"?
Your at-risk amount starts with
• Cash you contribute
• The carryover basis of property you contribute
• Any recourse debt you personally guarantee
It increases with additional contributions or income, and decreases with losses or distributions.
Why stock versus cash matters
Cash contributor:
If you wire $1M cash, you start with $1M at risk and can deduct up to that amount of depreciation.
Stock contributor:
If you transfer $1M of stock with only $50K basis, you start with just $50K at risk. Losses beyond $50K are suspended until your basis increases.
Order of deduction limits
At risk limitation under section 465
Passive activity limitation under section 469
Excess business loss cap under section 461
Example
Scenario | Cash Contribution | Low Basis Stock Contribution |
Initial investment | $1M cash | $1M market value stock (basis: $50K) |
Starting at risk | $1M | $50K |
Year 1 depreciation allocated | $120K | $120K |
Deductible Year 1 | $120K | $50K |
Suspended balance | 0 | $70K |
Suspended losses can be deducted later, once your at-risk amount increases through more income or contributions.
Takeaway: Cash contributors can deduct more upfront because they have more at risk, while low-basis stock contributors may have losses suspended until their basis catches up.
This example is for illustrative purposes only and simplifies several tax rules. Actual deductions depend on your specific facts, basis, and IRS rules. Consult your tax advisor to understand how these limits apply to you.
Please read our full disclosures before making an investment decision.