The Carried Interest Debate: Legislation That Threatens the Real Estate Industry

By Richard Parent and David Thaw, Gumbiner & Savett Inc.:
On June 24, 2010, the Senate failed to pass the House-approved American Jobs and Closing Tax Loopholes Act (H.R. 4213), which was the legislation that, in part, proposed to change the way carried interest is taxed. Whether some version of the carried interest legislation will be voted on in the Senate this year is uncertain.

Richard Parent

David Thaw

On June 24, 2010, the Senate failed to pass the House-approved American Jobs and Closing Tax Loopholes Act (H.R. 4213), which was the legislation that, in part, proposed to change the way carried interest is taxed. Whether some version of the carried interest legislation will be voted on in the Senate this year is uncertain.

Carried interest is a financial interest in the long-term capital gain of a real estate project given to a managing partner by the investors in a partnership. It is earned if the property is sold at a profit that exceeds the agreed upon returns to the investors. This allows the managing partner to share in the upside of the real estate venture and to compensate the managing partner for the services rendered and risks assumed during development of the project and the period prior to sale of the property.

Under current tax law, carried interest is taxed at long term capital gain rates of 15 percent. The change would tax a blend of ordinary income and capital gains, potentially increasing rates to 35 percent or more. The proposed legislation would tax 75 percent of carried interest income at ordinary tax rates unless the assets generating the carry were held for at least five years. Carried interest on assets held for at least five years would be taxed 50 percent at ordinary income rates and 50 percent at long term capital gain rates.

Real estate projects are typically structured utilizing partnerships, and therefore, often involve a carried interest. Real estate projects structured as partnerships would have to consider modifying their structure, possibly decreasing the after tax rate of return to investors. This could lead to some investors investing in non-real estate investments.

If carried interest legislation were to pass, it could significantly impact commercial real estate and possibly further delay an economic recovery in the industry. Real estate managing partners would pay more taxes and see narrower margins, reducing their ability and incentive to make risk-based investments. Increasing the tax burden could also result in fewer jobs, fewer economic development projects and fewer small investors lifting our economy into recovery.