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not deductible when stock with no basis be (1) borrowed by the taxpayer with
is sold. respect to the activity of holding real
A shareholder of property; (2) secured by real property
an S corporation is
Example 2: Effect of stock sales on the used in the activity; and (3) borrowed
basis, at-risk, and PAL limitation: at risk for money from a commercial lender.
The facts are the same as in Example Planning tip: The qualified non-
1. Assume also that the corpora- and the adjusted recourse financing privilege generally
basis of property
tion uses a calendar tax year and P will be of limited benefit in connection
sells all of his stock to an unrelated contributed to the with an S corporation because an S
person for $20,000 on Jan. 1 of shareholder is not permitted to in-
corporation.
the following year. The first-year crease either basis or amount at risk for
passthrough loss reduced his stock corporate-level debt. However, if a loan
basis to zero, so P will recognize to a shareholder is secured by qualified
a $20,000 gain from the sale. The borrowing). Shareholders do not receive nonrecourse financing associated with
gain does not increase stock basis, an increase in their at-risk amount for realty, it is possible to take advantage of
so P cannot deduct the $1,000 loss their share of corporate-level liabilities. this rule.
suspended under the basis limitation And, as with the rules applying to stock Amounts borrowed, whether recourse
rules. Gain on the sale of stock does, basis, an S shareholder does not receive or nonrecourse, are not considered to be
however, increase at-risk basis and an increase in their at-risk amount for at risk if they are from any person who
allows P to deduct the $4,000 loss corporate-level debt that is personally has an interest in the activity or is related
suspended under the at-risk rules. guaranteed (Prop. Regs. Sec. 1.465-6(d)). to a person having such an interest in
Furthermore, the $6,000 loss sus- Sec. 465(b)(2) provides that a tax- the activity (Sec. 465(b)(3); Regs. Sec.
pended under the PAL rules can be payer is considered at risk with respect 1.465-8; Van Wyk, 113 T.C. 440 (1999)).
deducted because P disposed of his to borrowed amounts only if the tax- However, a person who has an interest
entire interest in the passive activity payer is personally liable for repayment only as a creditor with respect to the ac-
to an unrelated party. (i.e., it is a recourse obligation) or, in tivity is not a prohibited party.
the case of a nonrecourse obligation, if Amounts borrowed from party
Deducting S corporation losses the taxpayer has pledged property, other with an interest in the activity: For
that are restricted by at-risk than property used in the activity, as amounts borrowed after May 3, 2004,
limitations security for the borrowed amount. In the loans from persons involved in the activ-
A shareholder may claim deductions case of nonrecourse borrowings secured ity will not increase at-risk limitations
from an activity only to the extent of by pledged property, the at-risk amount if the lender is involved in any activity
the aggregate amount for which the is limited to the net fair market value engaged in by the taxpayer (1) in carrying
taxpayer is at risk at the close of the S of the taxpayer’s interest in the pledged on a trade or business or (2) for the pro-
corporation’s (not the shareholder’s) tax property. The S corporation stock is duction of income (Secs. 465(b)(3) and
year (Sec. 465(a)(1); Prop. Regs. Sec. considered to be “property used in the (c)(3); Regs. Secs. 1.465-8 and -20).
1.465-1(a)). Since the measuring date is activity,” meaning that a shareholder
the last day of the year, changes in the is not considered at risk for amounts Example 3: Applying the at-risk rules
amount at risk during the S corpora- contributed or loaned to an S corpora- to stock and debt basis: D and several
tion’s tax year do not adversely affect tion when the amounts were obtained of her business associates formed W,
the shareholder. A shareholder of an S by nonrecourse borrowings secured by a calendar-year S corporation, on
corporation is at risk for money and the the corporation’s stock (Prop. Regs. Sec. Jan. 1 to operate a retail store sell-
adjusted basis of property contributed to 1.465-25(b)). ing wool products. D contributed
the corporation. A special exception allows at-risk in- $60,000 of her own funds to W in
Loans to S corporation may vestment for nonrecourse loans secured exchange for her portion of the stock.
provide at-risk basis: An S corpora- by real property used in the activity of She also borrowed $100,000 from her
tion shareholder has at-risk basis to holding real property (Sec. 465(b)(6); parents and loaned the funds to the
the extent of amounts loaned directly Regs. Sec. 1.465-27). To meet this “qual- corporation (in return for a written
to the S corporation (assuming the ified nonrecourse financing” exception, corporate note bearing a market rate
shareholder’s source of the funds was not no person can be personally liable for of interest). At the same time, D’s
a prohibited one, such as nonrecourse repayment, and the debt generally must father purchased 10% of the stock.

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