A New Capital Gains Battle: The “Carried Interest”

Published: July 2, 2007

<strong>To:        State and Local Association Executives</strong> <br /><font face="Times New Roman" size="3"><b>        State and Local Government Affairs Directors</b></font> <br /><font face="Times New Roman" size="3"><b>From:        Jerry Giovaniello, NAR Senior Vice-President Government Affairs</b></font> <br /><font face="Times New Roman" size="3"><b>RE:        A New Capital Gains Battle:  The “Carried Interest” </b></font><br /><br /><font face="Times New Roman" size="3"><b>The following is an update on the status of the &quot;Carried Interest&quot; debate in Washington D.C. </b></font><br /><br /><font face="Times New Roman" size="3">Legislation guaranteed to spark a ferocious new capital gains debate has exploded in Washington.  The bill, H.R. 2834, will have an <b><i>adverse impact on most real estate partnerships</i></b><i>.</i>  The legislation has been designated as a mechanism to generate revenue to “pay for” reforms to the Alternative Minimum Tax (AMT).  We wanted to inform you about this legislation and to let you know that we will likely call on you over the summer for significant grassroots input.  </font> <br /><br /><font face="Times New Roman" size="3"><b><i><u>Background</u>:</i></b><i> </i>Recently, the financial press has explored the private equity markets and has highlighted that these markets are not subject to any federal or state financial or securities regulation.  More specifically, Blackstone, a Wall Street private equity investment fund, has drawn attention not only for its recent public stock offering, but also for the huge compensation amounts that the fund managers have received.  The fund managers treat this particular type of income as capital gains income, taxed at 15%.  <i>The tax writing committees have been evaluating whether it is appropriate to continue to tax those earnings at capital gains rates.  Their answer is an emphatic NO.</i></font> <br /><br /><font face="Times New Roman" size="3"><b><i><u>What Does This Have To Do With Real Estate?</u> </i></b><i> </i>A reasonable person could conclude that the unregulated private equity market has created the perceived abuse, so the private equity market will likely bear the burden of correcting the situation.  Reasonable, but not what’s happened.  <i>The new legislation goes well beyond Wall Street and will reach not only private equity and most other investment funds (including pension funds), but real estate partnerships, as well.  LLCs and LLPs will likely be covered as well, as they are treated as partnerships.</i></font> <br /><br /><font face="Times New Roman" size="3"><b><i><u>What the Bill Does:</u> </i></b><i> </i> H.R. 2834 eliminates capital gains tax benefits for all partners or fund managers who provide “investment management services” to the partnership or fund.  The target is what’s called a “carried interest.” Carried interests can be thought of as a way to allow asset managers to “get a piece of the action” over and above their “regular” compensation.</font> <br /><br /><font face="Times New Roman" size="3">Similarly, a real estate carried interest grants a specially allocated portion of the profits to the partner(s) providing the services to operate the partnership.  The “carried interest” is usually activated when the property is sold.  Historically, that portion of profits has been taxed as a capital gain.  <b><i>H.R. 2834 specifies that those who provide services to manage and operate real estate partnerships will no longer receive capital gains benefits for those carried interests, but will pay tax at ordinary income rates on the carried interest.  </i></b></font> <br /><br /><font face="Times New Roman" size="3"><b><i><u>What Will Congress Do</u></i></b><i>?  </i>H.R. 2834 has prominent sponsorship.  The lead sponsor is Congressman Sander Levin (D-MI), a very senior member of the Ways and Means Committee.  Chairmen Rangel (D-NY) and Financial Services Committee Chairman Barney Frank (D-MA) are also sponsors, along with ten senior Ways and Means Democrats.  There is no companion Senate legislation, but Chairman Baucus (D-MT) and Ranking Member Grassley (R-IA) have introduced a related, but much less far-reaching bill.</font> <br /><br /><font face="Times New Roman" size="3">While no official estimates have been issued indicating how much revenue the Levin bill will generate, its scope suggests that it is likely to generate tens of billions in “new” revenues.  Chairman Rangel has indicated his intent to use this “new” revenue to “pay for” Alternative Minimum Tax (AMT) reform.  </font> <br /><br /><font face="Times New Roman" size="3"><b><i><u>What is NAR’s Response?  </u></i></b>NAR is operating on two fronts.  An informal network representing around 100 organizations in dozens of industries is making an aggressive effort to kill this legislation.  All the major real estate organizations are working within that network.  In addition, NAR and the other real estate organizations have joined forces to assure that real estate partnerships will not be subject to any new rule that would modify the capital gains treatment that currently applies to real estate partnership carried interests.</font>

Last modified: July 2, 2007 at 7:53 am | Originally published: July 2, 2007 at 7:53 am
Printed: September 27, 2020