A "carried interest" (also known as a "promoted interest" or a "promote" in the real estate industry) is a financial interest in the long-term capital gain of a development. The “carried interest” is given to a general partner (GP), usually the developer, by the limited partners (LPs), the investors in the partnership. It is paid if the property is sold at a profit that exceeds the agreed-upon returns to the investors, and is designed to give the developer a stake in the venture's ultimate success. This serves to align the interests of the GP with the investors by allowing the GP to share in the "upside" of the real estate venture. It also serves to compensate the GP for the substantial risks taken during development of the project and during the period prior to sale of the property. Carried interest has traditionally been treated as capital gains income taxed at favorable capital gains rates.
Efforts to change the taxation of carried interest began in 2008. Supporters of legislation to tax carried interests at ordinary income rates described it as eliminating a loophole used by Wall Street private equity and hedge fund managers to avoid taxes. However, the change would also disproportionately impact the real estate industry since real estate partnerships comprise a large number of partnerships and many use a carried interest component in structuring development ventures.
In order to address concerns regarding hedge funds characterizing service income (taxed as ordinary income rates) as carried interests (taxed at lower capital gains rates), the Tax Cuts and Jobs Act of 2017 imposed a three-year holding period before a carried interest could be afforded tax treatment as a capital gain. Despite this change, H.R. 1068, “The Carried Interest Fairness Act of 2021” has been introduced in Congress to eliminate capital gains tax treatment for carried interests. The Biden Administration has also included a provision to eliminate capital gains treatment for carried interests in its American Families Plan, presented to Congress on May 28, 2021.
NAIOP opposes a change in the tax treatment of carried interest that would result in an increase in tax rates from capital gains to ordinary income rates. These proposals ignore the changes already made in law requiring a three-year holding period for carried interests to be afforded capital gains tax treatment.
Carried interest taxation is a part of the current congressional debate over President Biden’s “American Families Plan” proposal debate.