Basis, At-Risk, Passive Loss: What Order Do the TCP Limitations Go In?
A loss may need to survive several limitation gates before becoming currently deductible. The order matters.
Gate 1: basis
Start with whether the taxpayer has sufficient basis to absorb the loss under the applicable entity rules. Basis creates the first ceiling. If there is not enough basis, some loss may be suspended.
Gate 2: at-risk rules
Next, determine how much the taxpayer is economically at risk for. A taxpayer may have tax basis without being fully economically exposed in the way required by the at-risk rules.
Gate 3: passive activity rules
Then determine whether the activity is passive and whether the taxpayer has sufficient passive income or another applicable rule allowing the loss.
Why order matters
You cannot jump directly to “passive activity, therefore suspended.” Part of the loss may already be limited by basis. You need to know which rule captured which portion, especially when facts change later.
Suspended does not mean gone forever
A suspended loss may become available in a later year if the relevant limitation changes. Basis may increase, at-risk amount may increase, passive income may become available, or a qualifying disposition may occur.
Build three separate trackers
Track basis-suspended loss, at-risk-suspended loss, and passive-suspended loss separately. That makes multi-year questions much easier.
Do not forget entity-specific rules
S corporation shareholders and partners can have different basis mechanics. Understand the entity rules before applying the later limitation gates.
The takeaway
A loss can be economically real and still not be deductible today.
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FAQ
Does basis come before passive activity limitations?
Generally, basis and at-risk limitations are considered before the passive activity limitation in the applicable framework.
Are suspended losses permanently gone?
Not necessarily. They may become deductible when the relevant limitation is later satisfied, subject to the rules.
Should I track each type separately?
Yes. That makes multi-year questions much easier.