The Treasury Department and Internal Revenue Service (IRS) on January 7 issued final 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 final regulations, like the proposed carried interest regulations released last year, 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.
The final carried interest regulations also adopt several changes favorable to taxpayers:
In some cases, a general partner will borrow funds to contribute to a partnership. Whereas under the proposed regulations, a capital account did not include the contribution of funds attributable to a loan from another partner, the partnership, or a related person until loan amounts were repaid, the final regulations allow such contributions to count toward an individual service provider’s capital account balance so long as the individual service provider is personally liable for the loan.
An individual service provider is personally liable for a loan if: (1) the loan is fully recourse to the service provider; (2) the service provider has no right to reimbursement from another person; and (3) the loan is not guaranteed by another individual.
In addition, the proposed regulations required taxpayers to recognize for tax purposes the transfer of applicable partnership interests to related parties if such transfer occurs within the three-year holding period. This would have made it difficult to transfer applicable partnership interests even if the tax code generally otherwise treats such transfers as non-recognition events. The final regulations accelerate the recognition of income upon the transfer of an applicable partnership interest only to the degree that such a transaction would otherwise trigger a recognition event under Chapter 1 of the tax code.
NMHC has long advocated 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.
For more information on this topic, please visit the NMHC carried interest webpage.
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