Losses allocated to a shareholder through their Schedule K-1 are only deductible to the extent the shareholder has sufficient stock basis and debt basis. If allocated losses exceed basis, the excess is suspended — carried forward indefinitely until the shareholder restores enough basis to absorb them. Furthermore, distributions that exceed basis are treated as capital gain, not tax-free return of investment. This is why annual basis tracking is not optional — it directly controls the tax value of the pass-through structure. Shareholders who fail to maintain accurate basis schedules routinely over-deduct losses, triggering IRS assessments with interest and penalties.