Policy Issues

CARRIED INTEREST

Issue Position Background

ISSUE

A “carried” interest is the interest in partnership profits that a general partner receives from the investing partners for managing the investment and taking on the entrepreneurial risk of the venture. Carried interest may be taxed as ordinary income or capital gain depending on the character of the income generated by the partnership. Lawmakers have introduced various proposals to change the tax treatment of carried interest since 2007. In the Tax Cuts and Jobs Act of 2017, Congress created a three-year holding period requirement in order for carried interest to qualify for the reduced long-term capital gains rate.

In the 117th Congress, the Carried Interest Fairness Act (Representative Bill Pascrell, D-NJ) would have converted virtually all carried interest income attributable to gain from the sale of real estate to ordinary income subject to both ordinary income tax rates and self-employment taxes.

President Biden’s Build Back Better agenda called on Congress to “close the carried interest loophole so that the hedge fund partners will pay ordinary income rates on their income just like every other worker.”

The version of the Build Back Better Act approved by the House Ways and Means Committee would have extended the current holding period required for carried interest to qualify for long-term capital gains treatment from three years to five years. However, the extension of the holding period would include an important new exception for a real property trade or business (e.g., real estate). Other aspects of the House proposal would indirectly extend the required holding period by not starting the clock until all assets have been acquired by the partnership.

The Ways and Means Committee-approved changes to carried interest tax rules were dropped from the bill before its passage by the full House.

In the Senate, legislation proposed by Finance Committee Chairman Ron Wyden (D-OR) would treat carried interest as an interest-free loan from the limited partners to the general partner that is taxable upon grant, regardless of whether the partnership ever generates any profits.

An initial budget reconciliation agreement between Senate centrist Joe Manchin (D-WV) and Senate Democratic Leader Chuck Schumer (D-NY) would have included the House Ways and Means-proposed changes to carried interest. However, the carried interest provisions were dropped from the final legislation at the insistence of Senator Kyrsten Sinema (D-AZ).


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Position

 

The tax code should continue to reward risk-taking, and Congress should reject tax changes that limit capital gains treatment to invested cash.

Background

  • Much of the real estate investment that takes place today uses the partnership choice of entity. Real estate partnerships represent 50% of the nearly four million partnerships in the United States and include over eight million partners.
  • Proposed carried interest changes would harm small businesses and partnerships, stifle entrepreneurial risk-taking and sweat equity, and threaten improvements and infrastructure in long-neglected neighborhoods most in need of investment.
  • Carried interest is not compensation for services. General partners receive fees for routine services such as leasing and property management. Those fees are taxed at ordinary tax rates.
    • Carried interest is granted for the value the general partner adds to the venture beyond routine services, such as business acumen, experience, and relationships. It is also a recognition of the risks the general partner takes with respect to the general partnership’s liabilities. These risks can include funding pre-development costs, guaranteeing construction budgets and financing, and exposure to potential litigation over countless possibilities.
    • Some carried interest proposals would apply retroactively to prior transactions—effectively raising taxes on sales that have already occurred.
    • Moreover, the legislation would capture and apply to partnership agreements that were executed years— often decades—earlier. These negotiated agreements between the partners were based on well-established tax law as it existed at the time. By changing the tax results years later, the bill would undermine the predictability of the tax system and discourage the long-term, patient investment that moves our economy forward.
    • In short, these proposals would make it more expensive to build or improve real estate and infrastructure, including workforce housing, assisted living communities, and industrial properties, to name just a few. Some development simply won’t happen, especially in long-neglected neighborhoods or on land with potential environmental contamination.

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