The Treasury Department and Internal Revenue Service (IRS) on July 31 issued long-awaited proposed carried interest regulations. While the Tax Cuts and Jobs Act (TCJA) generally establishes a three-year holding period for a carried interest to be treated as a long-term capital gain, the proposed regulations exclude so-called Section 1231 gains from the extended period. Section 1231 generally applies to real property used in a trade or business that is held for more than one year and is not held by a taxpayer primarily for sale to customers.
NMHC and NAA believe that carried interest should be treated as a long-term capital gain if the underlying asset is held for at least one year. The industry strongly opposed extending the holding period to three years as part of TCJA but is pleased the law does not lengthen the one-year holding period applicable to Section 1231 gains. Notably, for any carried interest subject to a three-year holding period for long-term capital gains treatment, the proposed regulations provide that the holding period of the owner of the asset sold is controlling.
Carried interest should receive long-term capital gains tax treatment because it represents a return on an underlying, long-term capital asset, as well as risk and entrepreneurial activity. This is in contrast to any fees that managing partners receive in payment for operations and management activities, which are taxed as ordinary income. A higher tax rate on long-term capital gains would discourage real estate partnerships from investing in new construction at a time when demand for apartments continues to grow and chronic underbuilding has limited new housing supply.
For more information on this topic, please visit the NMHC Advocacy webpage.
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