About That Carried Interest Provision In the Tax Cut & Jobs Act

WASHINGTON, DC–One of the provisions of the Tax Cut & Jobs Act increased the holding period to qualify carried interest as a capital gain from 1 year to 3 years.

Or did it?

Stephen Sharkey, a partner at DLA Piper, has his doubts based on a technical reading of the new tax law. “When you look at the language of the bill, you will see there is a cross reference to a capital asset. Well, guess what — technically under the tax code real estate used in a trade or business is not a capital asset. It is what folks refer to as a 1231 asset and it has a special code provision under which you get capital gain treatment for commercial real estate even though it’s not a capital asset.”

In other words, he says, in one part the law specifically calls out commercial real estate. Then in another part, it uses a cross reference that doesn’t include it. The question is, which is accurate?

Sharkey thinks this was unintentional on the part of Congress, and will require Congress to fix it. In the meanwhile, he says there is a lot of hand-wringing in legal circles about how to handle carried interest. “The operative language that requires a taxpayer to have held an interest in a property for three years refers to capital assets — and that doesn’t pick up commercial real estate.”

In short, it is Sharkey’s opinion that the one-year hold period is still the law, not the three-year hold period.

That benefits companies that are closing deals now and until Congress issues a technical correction. “But it would be poor judgement to go around planning transactions based on the theory that real estate has been excluded,” he says.

Some attorneys, Sharkey says, believe that real estate was deliberately excluded from the law. “Personally I think that is wistful thinking.”

Until Congress issues another bill correcting this and other mistakes in the tax bill, the real estate industry won’t know for sure.