Carried Interest Provisions Removed from Inflation Reduction Act
Section 1061, a provision of the Tax Cuts and Jobs Act, was enacted in 2017. Under current law, a taxpayer whose carried interest is subject to section 1061 may still recognize long-term capital gain with respect to assets that have been held for at least three years. Section 1061 speaks directly to real estate, hedge fund, and private equity professionals and managers.
Overview of proposed carried interest changes
Many administrations have tried to change the tax laws surrounding carried interests. The proposed provisions found in the Biden administration’s Inflation Reduction Act included:
- Increased the holding period requirement to avoid the recharacterization of the carried interest holder’s long-term capital gain to short-term capital gain from three years to five years
- Required that the partnership had acquired substantially all its assets to start the running of the five-year holding period
- Made the §1231 gain from the sale of “operating” real estate subject to §1061
- Triggered gain on the gift of an applicable carried interest that had not satisfied the five-year holding period
The proposed amendments to section 1061 would have been effective for taxable years beginning after December 31, 2022.
Tax planning opportunities
The proposed carried interest tax changes were taken off the table to gain Senator Kyrsten Sinema’s support of the Inflation Reduction Act. To replace the revenue lost from the carried interest changes, the Act would impose a 1% excise tax on the value of public company stock buybacks.
Partnerships and real estate professionals can take advantage of tax planning opportunities including:
- A holder of an applicable carried interest still can engage in estate planning transactions of interests having equity build-up without income recognition and move future appreciation in the carried interest out of the holder’s estate.
- A holder of an applicable carried interest that has appreciated significantly may want to consider gifting a portion of the carried interest to a Donor Advised Fund (DAF) and claim a charitable contribution deduction for the full fair market value of the carried interest.
Lawmakers will continue to see carried interest as an easy opportunity to generate additional tax revenue without placing a greater tax burden on middle-class taxpayers. We will monitor and provide updates on this and other tax legislation that may impact you and your business.
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