Real Estate Investment “Promoters” Could Face an Unintended Drastic Tax Increase from the “Carried Interest” Provisions of the President’s 2014 Budget Proposal

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Over the past years there have been many discussions in Washington of taxing Carried Interests at ordinary tax rates, and we at Nienow & Tierney, LLP have been consistently monitoring this issue facing our real estate clients.  The President’s 2014 budget blueprint issued in April includes such a provision.

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. These arrangements are often referred to as “promote interests” as well.  The Internal Revenue Code contains provisions that tax “carried interests” at the more favorable capital gain tax rates when the underlying assets are disposed of for a profit.

In an effort to target large investment fund managers that utilize this provision, the President’s latest budget proposal aims to treat the income from the eventual success of the venture as compensation for services, taxed at ordinary tax rates.  The result is a potential tax rate increase from 20% to 39.6% on such income, or approximately twice the tax they pay now.

Many of our clients are Southern California real estate investment “promoters”, that engage in the business of finding poorly operated and undervalued commercial real estate properties that they feel they can bring value to.  Typically they will raise capital through private investment (so called “friends and family equity”), or institutional investors, and share in the profits generated in excess of a preferred return to the investors.  It appears that the President’s budget proposal would (unintentionally?) lump these ventures in with the multi-billion dollar Wall Street investment funds he hopes to raise revenue from.

Because this is an important issue to our clients in the real estate industry, we will continue to monitor these legislative developments, and we will contact our clients to help proactively plan should this legislation become law.

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