Uncertainty Exists for Investment Partnerships over the President’s Proposal to Increase Taxes on Carried Interests

by

On September 12, 2011, the Obama administration submitted statutory language for the proposed American Jobs Act to Congress. As detailed here, the Administration’s proposal contains a number of provisions, including an updated proposal to tax carried interest as ordinary income. If you have been following our blog, you know that the carried interest proposal has been floated numerous times over the past five years, and we have detailed its potential impact on real estate investment firms.  The Administration’s proposal, however, makes some significant changes as compared to earlier versions, and so it is noteworthy to look into the current status of these proposed changes.

Background

The Internal Revenue Code contains provisions that tax “carried interests” at the more favorable capital gain tax rates.  Carried interests can loosely be defined as interests in partnerships and funds held by the investment organizer based on their efforts to put the venture together.  In an effort to target large investment funds that utilize this provision, tax proposals, including this latest one, aim to treat the income from the eventual success of the venture as compensation for services, taxed at ordinary tax rates.  In the past, there has been no distinction between the multi-billion investment funds of Wall Street, and the friends and family real estate investment partnership of Main Street.

Latest Proposals

The latest proposed legislation introduces a concept of an “investment partnership” and a revised definition of “investment services partnership interest” (ISPI).  It appears that the intention of these new definitions is to narrow the application of the rule recharacterizing capital gain as ordinary income, and we are hopeful that it will provide an exception for our clients in the real estate industry.

For now, it appears that the treatment of gain on the sale of an interest in a partnership that serves as an investment manager but also owns a carried interest, fee waiver or other interest in the underlying investment entity it manages is not entirely clear and may depend on the specific facts and circumstances.  These concepts may be further clarified during the legislative process and we will continue to monitor them and provide pertinent information here.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


%d bloggers like this: