Tag: Carried Interest

A group of Senate Democrats introduced legislation this week that would tax carried interest capital gains income at ordinary income tax rates of up to 40.8%. (Bloomberg Tax April 16)

Carried Interest Proposals

• The Carried Interest Fairness Act was introduced on April 15 by Senate Banking Committee Chairman Sherrod Brown (D-OH) along with Sens. Tammy Baldwin (D-WI), Joe Manchin (WV), and several other Democratic co-sponsors.

• According to Sen. Brown, the change would raise $6.5 billion in revenue over 10 years. The Senators introduced a similar bill in 2021. (Sen. Brown news release; Crain Currency, April 16)

• This week’s carried interest bill is part of a broader effort by congressional Democrats to position legislative changes in anticipation of the expiration of 2017 Tax Cuts and Jobs Act provisions at the end of 2025. The approaching expiration of those individual provisionsis likely to drive tax negotiations next year into what some policymakers have referred to as the “Super Bowl of Tax.” (Bloomberg Tax, Jan. 4 and Axios, Feb. 16)

Democratic Proposals

• President Biden’s 2025 budget also proposes taxing all carried interest as ordinary income. Most of the Biden tax agenda is carried over from his prior budgets. (Roundtable Weekly, March 15 and March 8 | White House Fact Sheet, March 11)

• Senate Finance Chair Ron Wyden (D-OR) introduced legislation last year to treat the grant of carried interest as deemed compensation in the form of an interest-free loan from the limited partners to the general partner (GP). (Bloomberg Tax, Nov. 15, 2023)

• The Roundtable has consistently opposed these and similar proposals since 2007 for failing to recognize that carried interest is actually granted for the value a General Partner adds beyond routine services, such as business acumen, experience, and relationships.  Carried interest also reflects a recognition of the risks the GP takes with respect to the partnership’s liabilities—e.g., funding predevelopment costs, guaranteeing construction budgets, and potential litigation.

• Carried interest changes would also harm small businesses, stifle entrepreneurs and sweat equity, and threaten future improvements and infrastructure in neglected areas. They would increase the cost of building or improving infrastructure, workforce housing, and other socially desirable projects.

The Tax Cuts and Jobs Act of 2017 created a three-year holding period requirement for carried interest to qualify for the reduced 20% long-term capital gains rate.

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The need for policymakers to preserve longstanding tax law governing partnerships and profits interests – carried interest – was the focus of a June 16 letter sent by The Real Estate Roundtable and 14 other national real estate organizations to congressional tax writers. 

Pending Proposals

• The Biden administration’s budget includes a proposal to tax carried interest as ordinary income.  The Biden proposal, as well as pending House legislation (the Carried Interest Fairness Act, H.R. 1068), would result in an enormous tax increase on Americans who use partnerships to develop, own, and operate real estate. (Roundtable Weekly, Feb. 27 and April 30)
• The real estate coalition’s letter emphasized that the proposed changes to taxation of carried interest would:
  • Increase the cost to construct or improve real estate and infrastructure, including workforce housing, senior living communities, industrial properties or investments that support economic inclusion or bring environmental benefits; 
  • Create unintended consequences for local communities. Property taxes on real estate contribute 75 percent of local tax revenue and provide a stable and reliable source of funding for critical public services like education and law enforcement; 
    
  • Create new tax barriers during the post-COVID era as buildings throughout the country need to be repurposed and converted.

Reality vs. Perception

• The industry letter to policymakers also countered the false narrative that the carried interest issue targets only a handful of hedge fund billionaires and Wall Street executives. The letter notes the following realities:
  • The IRS reports that real estate partnerships represent half of the four million partnerships in the United States. These two million partnerships and their 8.6 million partners who own and operate multifamily rental housing, office buildings, shopping centers, hotels, distribution centers, senior living communities, and other commercial real estate in every town, city, and region of the country would face damaging impacts.
  • Carried interest involves recognition of the risks a general partner takes, including the funding of predevelopment costs; guaranteeing construction budgets and financing; and exposure to potential litigation.

Retroactive Change

• The letter also notes that current proposals would limit capital gain treatment only to taxpayers who have cash to invest. Those who invest entrepreneurial innovation, risk taking, and sweat equity would no longer receive capital gain treatment.
• The proposals would also apply retroactively to partnership agreements executed years, often decades, earlier.  Changing the tax treatment of proposals agreed to years earlier would undermine the predictability of the tax system and discourage long-term investment that encourages economic growth, according to the letter.

The Roundtable’s Tax Policy Advisory Committee (TPAC) met June 16 during The Roundtable’s Annual Meeting to discuss the carried interest proposals and the current tax legislative landscape in Washington. 

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The Real Estate Roundtable on Oct. 5 submitted detailed comments to the Treasury Department and IRS on proposed regulations implementing the 3-year holding period requirement for carried interests to qualify for long-term capital gain treatment.  (Roundtable comment letter)

• Treasury on July 31 released the proposed rules under IRS Section 1061 to address the specific conditions that apply to the 3-year holding period requirement passed by Congress in the Tax Cuts and Jobs Act (TCJA) of 2017.  (Roundtable Weekly, Aug. 7)
• The Roundtable commended the agencies for a balanced approach on certain key issues addressed in regulations – yet recommended further clarifications and improvements to the proposed rules to retain the original intent of Congress.  
• The Roundtable’s comments note that the IRS rules include a number of well-designed provisions that should help avoid unintended consequences when the 3-year holding period is implemented, including:

—  The 3-year requirement is limited to the gain from a sale or exchange of a capital asset – and excludes gain from property used in a trade business (Section 1231 gain). 

—  A useful “look-through” rule to help ensure REIT dividends paid to shareholders receive the same long-term gain treatment that would apply to assets owned individually or in partnership form.

—  A sensible exclusion to ensure a partner’s own capital contributions to the partnership are not subject to re-characterization under section 1061.

Recommendations for Additional Clarifications and Improvements

The Roundtable comment letter also recommends certain changes to the proposed regulations to bring the rules more in line with the legislative intent when Congress enacted section 1061.  The Roundtable recommendations include the following:

• Provide a safe harbor to allow funds borrowed by a general partner to qualify as a capital interest in the partnership.  Investors frequently require a general partner to co-invest in the partnership to align the parties’ interests.  These co-investments often are financed with loans from the investors.  The proposed regulations would undermine the economics of these arrangements. The 3-year holding period would apply when an investment is made with funds borrowed from the other investors in the partnership.  The Roundtable recommends that the Treasury narrow the broad restriction on borrowed funds by creating a safe harbor for non-abusive situations.
• Prevent improper acceleration of tax liability when a partnership interest is transferred in a nonrecognition transaction.  Section 1061(d) creates certain tax consequences for transfers of partnership interests to related parties.  The proposed regulations broadly interpret section 1061(d) to override other nonrecognition provisions in the tax code by requiring the inclusion of gross income as a result of such transfers.  The Roundtable recommends that Treasury narrow its current interpretation of the provision to avoid accelerating tax liability in the case of transfers of partnership interests to related parties in nonrecognition transactions.
• Avoid casting too broad a net on partnerships covered by the 3-year holding period.  Congress limited section 1061 to partnership interests in businesses that raise or return capital on a regular, continuous, and substantial basis.  The proposed rules, however, largely disregard this prong of the test and could capture many real estate arrangements unintended by lawmakers, including joint ventures, operating partnerships, and others.  The Roundtable recommends that Treasury limit application of the provision to businesses that meet the statutory requirements. 

Roundtable President and CEO Jeffrey DeBoer concludes the letter by noting, “Congress . . . narrowly drafted section 1061 to apply to specific situations.  Our comments our aimed at preserving the drafters’ intent while avoiding unnecessary disruption to common, everyday real estate partnerships—small and large—throughout the country.”

The recommendations were developed by The Roundtable’s Tax Policy Advisory Committee (TPAC).

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