CPA & Business Advisory Blog

New Bill May Change the Way Carried Interest is Taxed

Real estate professionals may want to keep a close eye on the American Jobs and Closing Tax Loopholes Act (H.R. 4213). The bill, which would extend the filing deadline for existing tiers of unemployment benefits and extend COBRA health care subsidies for the unemployed, contains a provision to alter the way “carried interest” is taxed.


Carried interest, according to Building Owners and Managers Association International, is described as follows –


“Real estate is a long-term, risk–based investment which is regularly structured as a partnership, and therefore often involves a component known as “carried interest.” The partnerships are made up of limited partners and general partners. The limited partner(s) provides the money and capital, has very little say in the operation of the investment and is simply looking for a particular return on the investment. The general partner(s) brings the “sweat equity” to the investment and does the day-to-day work making sure the property is properly managed and is compensated by a flat fee that is taxed as ordinary income. They are also offered an additional percentage of the profits as incentive to make the investment prosperous without contributing any capital of their own; this compensation is what is known as “carried interest.” When the general partner receives the “carry” it is taxed as a capital gain. It is paid only when, and if, the real estate investment actually is successful.”


Current law taxes the “carried interest” of a general partner in a real estate partnership as a capital gain. The House bill treats carried interest as 50% ordinary income and 50% long-term capital gains for two years, then moves to a permanent 25/75 split (25% long-term capital gains/75% ordinary income) with an effective date of Jan. 1, 2011.  


This change in tax law could disrupt the investment relationship between entrepreneurs and their capital finance partners.


The U.S. Senate is expected to consider action on the House bill this week. Real Estate professionals who will be affected by the new law may want to consider contacting their senator.


For more information on how this potential law change may affect your real estate operation, please contact our Real Estate & Construction Group at 440-449-6800.

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