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