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Application of New Holding Period for Carried Interests to Real Estate


“Carried interests” have been used to provide compensation for investment managers of hedge funds or private equity funds taxed at capital gain rates. Such carried interests have been subject to criticism by political figures as providing an unfair tax advantage for compensation of highly paid investment managers. President Trump made elimination of the tax advantage for use of carried interests as compensation for services as one of his campaign promises. A carried interest is nothing more than a profits interest in an entity taxed as a partnership (including most limited liability companies) allowing for pass through of gain from sales of capital assets of the entity held for more than one year characterized as long term capital gain. In response to this perceived unfair tax advantage, Section 1061 was added to the Internal Revenue Code as part of the Tax Cuts and Jobs Act signed into law in December 2017 to extend for three years the holding period for gains attributable to distributions to, sales of, or redemption of carried interests. Although the impetus for this new law came from the perceived unfairness of the tax treatment for compensation from private equity funds and hedge funds, compensation from equity interests in real estate projects is also affected.

Under Section 1061, gain from “applicable partnership interests” is taxed as short term capital gain unless held for more than three years. Short term capital gain is subject to taxation at ordinary income rates. An “applicable partnership interest” is a partnership interest transferred to, or held by, a taxpayer in connection with performance of services in an “applicable trade or business.” An “applicable trade or business” is an activity that consists of two parts. The first part is “raising or returning capital.” The second part is activity in connection with “specified assets.” That would include investing in, disposing of, identifying or developing “specified assets.” “Specified assets” include securities, commodities, real estate held for rental or investment, cash or cash equivalents or options or derivative contracts. Any of these assets held in tier partnership structures will make a partnership interest in the structure a “specified asset.”

Section 1061 applies to all applicable partnership interests held as of January 1, 2018, or at any time thereafter. So a partnership interest meeting the parameters of Section 1061 that was created prior to January 1, 2018, is subject to the three year holding period. There is no grandfathering.

Our clients in the business of real estate rental or investment will be affected by this change in the law if they issue partnership interests or limited liability company membership interests to employees or consultants and if they are engaged in raising capital. Partnership interests that are issued for capital contributions that share in partnership capital commensurate with the amount of capital contributed are not subject to the three year holding period.

However, the committee report states the intention that a partnership interest will not fail to be treated as issued in connection with performance of services merely because some amount of capital is also contributed. The committee report directs the Treasury Department to issue regulations to provide guidance on this intention. This raises a question as to whether or not a partnership structure with a promote allocation would be subject to the three year holding period for the promote allocation. A provision which may help in some project structures is the special rule in Section 1061(b) which provides as follows:

To the extent provided by the Secretary, subsection (a) shall not apply to income or gain attributable to any asset not held for portfolio investment on behalf of third party investors.

For this purpose, “third party investors” are persons who do not hold assets in connection with an applicable trade or business and are not engaged in providing substantial services for an applicable partnership or applicable trade or business. This would seem to exclude capital sources that are private equity funds, REITs, and institutional investors. To the extent a structure with a promote is funded by those capital sources which are not within the definition of “third party investors,” hopefully the guidance from the Treasury Department will clarify that the three year holding period does not apply.

Unfortunately, the guidance needed from the Treasury Department on Section 1061 is not a high priority. It is unlikely that more information on the application of Section 1061 will be issued this year.

Please contact Douglas Landrum ( or Stanley Heyman ( for further information about the new three year holding period for carried interests.

Nothing in this Client Alert is intended to be tax, legal or investment advice. Taxpayers should consult with their own tax advisors to understand the impact of the new law concerning carried interests based on their own circumstances.