Tax Increase on Carried Interests Reintroduced by Senate Finance Committee

Posted on May 24, 2010 by Kevin Caiaccio

Last week, the Senate Finance Committee reintroduced the long-discussed proposal to increase the tax rate applicable to carried interests.  As I discussed here a few months ago, this proposal is bad policy and bad for commercial real estate investment. 

The arguments against this proposal are well stated in an opinion piece in the Wall Street Journal today by economist John Rutledge:

"The tax hike on carried interest is partly being sold as a tax on wealthy hedge-fund managers, but that is not the case. Hedge funds hold assets for short periods and generate short-term capital gains; their managers already pay taxes at ordinary income rates. Instead the tax will fall on those who make the long-term investments that generate long-term capital gains.

"In 2007, real estate made up the largest category (48%) of partnerships, representing $4.4 trillion in investments by 6.8 million investors. Most of those are small, one-or-two property partnerships where one partner puts up the money to buy a dilapidated building and the other is the general partner who manages the work to improve the property. If you triple the tax rate on the general partner, many of the small deals simply will not happen and fewer buildings will be renovated."

The sponsors of the bill, Sen. Max Baucus (D-Mont.) and Sen. Sander Levin (D-Mich.), have mislabeled this proposal as the closing of an individual tax "loophole" (PDF).  In reality, the current tax treatment reflects the true character of the income as long-term equity at risk. 

Rather than closing a "loophole," this proposal will create a disincentive for risk taking in real-estate ventures and should be opposed.

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Tax Increase on Carried Interests: Dead or Alive?

Posted on February 1, 2010 by Kevin Caiaccio

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.

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