Carried interest is subject to capital gains tax. This tax rate is lower than the income tax or self-employment tax, which is the rate applied to the management fee. However, critics of carried interest want it to be reclassified as ordinary income to be taxed at the ordinary income tax rate. Private equity advocates argue that the increased tax will subdue the incentive to take the kind of risk that is necessary to invest in and manage companies to profitability.
Notable examples of private equity funds that charge carried interest include Carlyle Group and Bain Capital. Carried interest is not automatic; it is only created when the fund generates profits that exceed a specified return level, often known as the hurdle rate. If the hurdle rate of return is not achieved, the general partner does not receive carry, although the limited partners receive their proportionate share.
Carry can also be "clawed back" if the fund underperforms. The clawback provision, when added to the other risks the general partner undertakes, leads private equity industry advocates to their justification that carried interest is not a salary—instead, it is an at-risk return on investment that is only payable based on performance achievement. Hedge Funds Investing. Your Privacy Rights.
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A carried interest oftentimes cannot even be valued at the time it is granted since its payment is contingent upon the ultimate success of the project. This makes it more in the nature of a long-term risk investment that should treated as capital gains.
Creation of Capital Assets: Real estate development, unlike other industries where carried interests are used, results in the creation of a tangible, capital asset: an office building, a housing project or an industrial development. The carried interest is given for the risks taken in the creation of this capital asset, which also gives rise to jobs and results in an increased tax base for the community. To increase the tax on carried interest for all partnerships, without regard to the underlying investment or its impact upon a community, would be shortsighted.
Undermines economic activity and job creation: A tax increase on carried interest would undermine entrepreneurial activity in the real estate development industry, and in other areas of the economy where risk-taking is needed. If the willingness to take development risk is reduced by much higher taxes on the ultimate return, then many job-creating development projects will simply not be undertaken.
Decreases investment in real estate: Increasing the tax rate on carried interest for real estate partnerships would adversely impact the flow of capital to real estate deals. Such a move would disrupt the investment relationship between entrepreneurs and their capital finance partners. If such a change were to take place, many general partners would demand a different compensation structure at the beginning in order to justify undertaking the risks of development, thereby making the investment less attractive to investors.
July Carried Interest Advertisement. May 19, Industry Letter to Congress. House of Representatives opposing a carried interest tax increase.
Industry Advertisement in Roll Call opposing carried interest tax increase. Sign In. Events and Sponsorship Corporate Events I. To embed, copy and paste the code into your website or blog:.
A few key takeaways from the Final Regulations are as follows: Real Estate Partnerships — In general, carried interests in partnerships that own capital assets are subject to the three year holding period of Code Section However, because of what many suspect is a drafting error, a Code Section asset is not subject to the extended holding period. Most real estate assets are considered Code Section assets. Therefore real estate partnerships with carried interest structures can often still receive LTCG treatment when exiting an investment prior to the end of the three year holding period if the partnership structures the exit event as a sale of the underlying real estate instead of a sale of the carried interest the sale of a partnership interest is considered a capital asset and not a Code Section asset and thus is subject to the three year holding period.
Capital Interest Exception — Code Section excludes from the API definition any capital interest in a partnership which provides the partner with a right to share in partnership capital pro rata with the amount of capital contributed or deemed contributed.
The Proposed Regulations provided an exception in the case of a bona fide purchase by an unrelated taxpayer that would not provide services to the partnership. Send Print Report. Gray Reed. Austin Carlson.
Brian Clark.
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