Tax Increase on Carried Interests: Dead or Alive?
There seems to be conflicting reports concerning whether the proposed tax increase on carried interests remains alive in Washington. The proposal passed the House in December, and its fate is now in the hands of the Senate. According to reports last week, the proposal appeared to be dead for this session. However, the Administration's budget released just this morning includes this tax increase.
The issue is whether carried interests should continue to be taxed at the lower capital gains rate (as they are under current law), or taxed at the higher rate for ordinary income. If passed, the bill could more than double the tax liability for real estate professionals who are compensated with a promoted interest in a partnership or LLC.
The proposal originally gained popularity after reports of hedge fund managers who made enormous sums of money and were being taxed at a lower rate than ordinary working Americans. While most of us are unsympathetic to wealthy hedge fund managers, the problem is the unintended effect that this tax increase would have on the real estate industry. Many real estate ventures, both large and small, are structured such that the promoters receive a carried interest in exchange for know-how and sweat equity.
As noted in this ICSC report , compensation of real estate managers is fundamentally different from hedge funds and private equity. In the case of RE promoters, the income from a carried interest is not guaranteed, and there is often a longer hold time before any profits are realized. Moreover, the promoters are often required to incur contingent liabilities in the form of loan guarantees.
As a matter of public policy, the proposed tax increase comes at a terrible time. Commercial real estate is already struggling, and this bill would create a disincentive for further risk taking and could lower property values even further.
If policymakers intend to help stem the decline in CRE markets and the resulting damage to the overall economy, this bill should be voted down or amended to limit its applicability to fund managers.
