Inflation Reduction Act

Examining the Proposed Changes to Carried Interest

 What is being discussed? 

Senate Democrats are poised to move the “Inflation Reduction Act” forward. The Democrats have positioned the bill as a way to “reduce the deficit and fight inflation”. However, included in the bill is a provision that would alter taxation of “carried interest” that would create new implications for managers of private-equity funds and real estate partnerships. 

What are the proposed changes to “carried interest”? 

Following the passage of the Tax Cuts and Jobs Act of 2017, Republicans largely left the treatment of carried interest intact, but did narrow the exemption by requiring private equity officials and partnerships to hold their investments for at least three years before capturing gains at the long-term capital gains rate. 

The proposed Act by Democrats would further narrow the exemption, in several ways. It would extend that holding period from three to five years, while also altering the way the period is calculated. Specifically, the holding period would start when all of a fund’s assets are acquired, or until a partner acquires substantially all of an interest in the partnership. 

What are the implications for real estate investors? 

Under the current law, most real estate partnerships are afforded special treatment pursuant to IRC Sec. §1231. This code allows real estate partnerships to capture the benefits of long-term capital gains treatment upon the sale of real property after one year. The proposed Act by the Democrats would extend the §1231 exemption from 1 to 3 years for real property trades. 

Changing the current law could discourage real estate partnerships from investing in new construction at a time when demand for apartments continues to grow and the nation is experiencing a housing shortage. In a recent study commissioned by NMHC/NAA, they concluded that the nation would need to build an additional 4.3 million more apartments by 2035 to meet the demand for rental housing. 

What’s next? 

The bill still needs to pass a senate vote. Moderate Democratic Senator Manchin has voiced support for the bill, but Democratic Senator Sinema has previously opposed closing the current carried interest rule. With lawmakers set for summer recess next week, only time will tell if Democrats can muster support from moderates in their wing to pass the Act. 

This Research Brief is general in nature and is not intended to be legal advice. For specific legal advice, consult your attorney.