WASHINGTON, DC—Official Washington DC has turned its attention, once again, to the issue of carried interest. The push to change the tax characterization of carried interest is a predictable talking point among politicians every few years in large part because hedge fund managers -- an elite group of investment managers that the general public is not inclined to rally around --  are the poster child beneficiary of the status quo.   But as the commercial real estate industry well knows, carried interest is core to deals in other industries as well.

"Increasing the tax on carried interest capital gain -- as is popular with some politicians these days -- would have far-reaching consequences for nearly every real estate partnership in the country," says Jeff DeBoer, CEO of The Real Estate Roundtable.  "Some consequences would be clearly visible, others not as much."

Make no mistake, he continued, "the way America has historically encouraged and incentivized every citizen to seek out long-term, productive investments would be altered dramatically, and jobs would suffer."

If DeBoer sounds alarmed in his statement that is because he probably is. Why? Well, my guess would be because in many respects this time the push to change carried interest is widespread and coming from some unusual suspects on the political spectrum.

There is more, however. The California Public Employees' Retirement System is starting to report how much it is dinged by carried interest, following the disconcerting realization that even this giant fund could not make sense of these fees.

Perhaps the biggest factor though is a proposed rule change by the Internal Revenue Service that, if it is put into place, will effectively make moot all of the aforementioned. The comment period for that proposal is ending Oct. 21, 2015.

Last and -- no disrespect intended for our law-making government body -- but least of all is a bill in Congress that will change the characterization of carried interest. I say "least" because there have been numerous attempts by Congress to do this, some of which have come close, but ultimately they have all failed.

This time, though, things are different.

Politicians Agree, Carried Interest Must Go

The political discourse has highlighted the issue, starting with Donald Trump, who is currently commanding the nation's bully pulpit with his campaign for the GOP nomination for presidential candidate. Trump called for an end to the carried interest tax break recently and while one Republican's proposal may have ended the discussion, another GOP presidential candidate Jeb Bush, also called for it in his tax proposal.

Democrats, including most notably President Obama, joined the chorus but their position was to be expected. Republicans have been, in the past, an unbreakable force standing firm against any changes. Now, not only are the most visible Republican presidential candidates calling for its elimination but a few of the so-called underdog candidates, such as Bobby Jindal and George Pataki, are as well.

The latest measure in Congress, the Carried Interest Fairness Act, comes with a revenue gain of $15.6 billion over the next ten years, according to the Joint Committee on Taxation, which provided the estimate in response to a request by one of the bill's sponsors, Ways and Means Committee Ranking Member Sander Levin (D-MI). Next year alone it could deliver $1.4 billion in revenue, according to the JoT's calculations.

The measure was little noticed when it was introduced in June by Levin and Senator Tammy Baldwin. Like other measures introduced before, it seeks to tax carried interest at ordinary income tax rates rather than the lower capital gains rate.

June, in retrospect, was a pivotal month for this issue -- or rather, the bill would prove to foreshadow more movement on carried interest than perhaps even its sponsors imagined.

The IRS Publishes a New Rule

About a month or so later, the Internal Revenue Service proposed a rule that would ban companies from converting the management fees they receive from their investors -- fees that would normally be taxed as ordinary income -- into capital contributions invested in their funds. The measure cited Section 707(a)(2) in the tax code which "grants the Secretary broad regulatory authority to identify transactions involving disguised payments for services…" as the source of its authority to make this change.

The IRS has since called for public comments on the issue, which are due on Oct. 21.

Pension Funds Demand Carried Interest Info

Meanwhile another source -- a very disconcerting one from the perspective of private equity -- is also taking another look at carried interest. That would be the pension fund investors, with CalPERS leading the way. These funds are not interested in the debate about how private equity should be taxed. Rather they are looking at how much carried interest is costing them.

CalPERS has been quietly working on getting more disclosure from its private equity general partners since 2011. At the start of this year it announced it would cut the number of private equity managers its uses by more than two-thirds to reduce costs for efficiency sake.

However the extent of its efforts came to light in April when a senior staffer told investment committee members that it was unable to track the carried interest that it had paid out to private equity fund managers over the years. State officials were predictably outraged and the spotlight has been on CalPERS and its carried interest reporting plans every since.

As CalPERS explained, its staff identified a need to better track and report private equity fees, carried interest, and other portfolio and fund level data in 2011 as its legacy system was not up to the task.

"Historically, fees and carried interest in the private equity industry have not been consistently reported by private equity managers," said Ted Eliopoulos, Chief Investment Officer for CalPERS, in a prepared statement. "A complex portfolio like CalPERS with a wide variety of economic terms and agreements that span a decade or more requires a comprehensive solution for accounting, tracking, and reporting of fees and carried interest."

It began working with the Washington DC-based International Limited Partners Association to develop its Private Equity Accounting and Reporting Solution (PEARS), a system to standardized disclosure.

But let's jump to the present tense for a moment: One can extrapolate that if CalPERS was unable to produce a specific number to plug into the question 'how much are carried interest fees costing us?' then smaller funds cannot either.

And one can then further extrapolate that these funds will soon, if they are not already, adopt CalPERS' lead on the matter. That is, they will start demanding the disclosure from private equity and then publishing it.

For that is what CalPERS is doing -- and as a matter of fact, the South Carolina Retirement System Investment Commission, as well.

CalPERS' move, though, raises the stakes considerably. It is reporting the total carried interest paid to the General Partners of the private equity investment funds it invests for the fiscal year ending June 30, 2015. The data is targeted for release this fall, representing the culmination of a multi-year systems and data collection initiative, CalPERS announced recently. "This is a major milestone and accomplishment, something we have been collectively focused on for the past three years," Eliopoulos said. "We are pleased that we can provide transparency and detail around the carried interest going forward."

To collect the data CalPERS is using the industry templates ILPA released in 2012, which are still a work in progress. CalPERS says it is continuing to collaborate with the ILPA group dedicated to this topic. (At the start of September ILPA announced its own related initiative, the Fee Transparency Initiative, which it describes as a broad-based effort to establish more robust and consistent standards for fee and expense reporting and compliance disclosures among investors, fund managers and their advisers.)

The majority of its GPs cooperated with the effort. The pension fund reports that since the beginning of 2015, 94% provided the carried interest amounts deducted from CalPERS gross returns with approximately 6% declining to do so. CalPERS also asked its private equity GPs to provide the pension fund carried interest since inception.

So far this is what it has found, according to its website. 

Investment returns (net of fees, including carried interest) have averaged:

• 8.9% for one year;

• 14.1% for three years;

• 14.5% for five years;

• 12.2% for ten years;

• 12.3% for twenty years.

"During these time periods, the returns have outperformed our peers in public pensions, according to an August report to the CalPERS Board of Administration," it said.

Now, granted, CalPERS is invested across a wide array of asset classes, all or most of which likely includes a private equity investment. But the fund also has an outsized presence in the commercial real estate asset class. Its reporting and disclosure will surely shed light on what are appropriate fees and returns -- and what are not -- for CRE partnerships. As will other pension funds' efforts in this area.

South Carolina's look at the matter was considerably more pessimistic.  In a report [PDF] published this month it blunted concluded that the fund earns too little, pays too much, its portfolio is overly expensive and complex and that if it had invested in index funds it would have had an additional $7 billion.

Ouch.

ILPA's initiative will also shed light on these fees. Not only is CalPERS active in its Fee Transparency Initiative, but so are such funds as Washington State Investment Board, the South Carolina Retirement System Investment Commission and Dutch pension manager APG.

So given all this, it is a fair to say that a sea change is coming for carried interest. Whether it is by law or executive action or by market forces almost doesn't matter at this point -- it is coming.