1. Boost Management Fees: Substitute higher base management fees to offset the potential loss of carried interest. This change would provide a more predictable income stream, even if ordinary income tax rates apply to that income.

2. Encourage Equity Co-Investment: Foster a culture of co-investment by encouraging sponsors to invest capital alongside the equity investments of their private equity investors. This approach not only more closely aligns interests but also allows sponsors to benefit from capital gains tax rates on income from their investments. Consider developing creative transaction structures with private equity investors that might facilitate sponsors in making these co-investments. 

3. Increase Performance Bonuses: As an alternative and additional way to reward managers, transition to performance-based bonuses (if they are not already used in deal structures) or increase these bonus payments, including through higher incentive management fees. These bonuses can be strategically aligned with the business plan for the asset and associated performance metrics. Since these bonuses would be taxed at ordinary income rates, the tax implications to sponsors and managers should be considered in determining the bonus amounts to be paid.

4. Evaluate Deferred Bonus Compensation Plans: Establish a “phantom equity plan” where sponsors would receive deferred compensation in amounts tied to the appreciation achieved by the real estate asset from the time of its acquisition through the date it is refinanced or sold and the share the sponsors would have been paid had they received carried interest distributions. While the payments under this compensation plan would be taxed as ordinary income, this structure would allow sponsors to defer income and its associated taxes to a future date, potentially when they are in a lower tax bracket. 

5. Joint Ventures and Partnerships: As a follow-on to the increased equity co-investments approach noted above, deals might be structured as genuine joint ventures or partnerships where all parties, including sponsors, make capital contributions, receive ownership interests commensurate with their contributed capital, and have equivalent management and decision-making control. This approach would be in lieu of the other suggested increased compensation arrangements and would provide sponsors with capital gains instead of ordinary income tax treatment for any return on capital that they receive if they comply with the required holding periods and other relevant requirements of the Internal Revenue Code (IRC).  

6. Utilize Equity Interest Options: Consider issuing “equity interest options” to provide long-term incentives that align managers' interests with company success, benefiting from favorable tax treatment under certain conditions. These types of equity compensation structures are an alternative way to allow managers to participate in the increased equity value of the real estate asset without making a current outlay. Real estate companies can also use them to align managers' interests with the asset’s success.  Such equity options issued by partnerships will result in ordinary income when the option is exercised based on the excess of the value of the equity at the time of exercise over the exercise price.  Equity options issued by corporations are generally subject to these same rules, but options issued by a corporation may qualify as more beneficial “incentive stock options” to a limited extent.  Incentive stock options will not result in ordinary income when exercised, so long as the stock received upon exercise of the option is held for at least two years after the option was granted and one year after the option was exercised.  However, the exercise of an incentive stock option can result in alternative minimum tax. 

7. Leverage Tax-Advantaged Opportunities: Investigate investments in tax-advantaged areas, such as opportunity zones, to take advantage of available tax incentives and offset other tax burdens.

8. Reevaluate Reinvestment Structures: For both existing partnerships and future deals, sponsors should reevaluate transaction structures that include a deferral of sponsor management or other fees and the conversion of those fees to notional capital interests. Under current IRS carried interest rules, these “fee waivers” may permit ordinary fee income to be converted into capital gains for distributions received by sponsors from a share of the partnership’s profit.  

If the favorable tax treatment for carried interest is terminated, it is likely that these deferred/converted fees would likely be treated as carried interest because of their nature as profits interests. Determining where a transaction structure presents this risk will allow sponsors to anticipate and prepare for additional ordinary income taxes that a project may generate.

9. Reassess Project Timelines: Evaluate the holding periods for properties to ensure they qualify for long-term capital gains, optimizing the tax strategies being implemented for each transaction.

10. Engage Tax Professionals: Maintain a close relationship with tax advisors to stay informed about legislative changes and explore innovative strategies and deal structures tailored to the company’s specific needs.

Pam Rothenberg ([email protected]) is a Partner in the Real Estate Practice Group at Womble Bond Dickinson (US) LLP and routinely negotiates joint venture agreements for her CRE clients.  Jeff Lawyer ([email protected]) is a Partner in the Firm’s the Tax Practice Group and regularly counsels CRE clients in joint venture transactions and other transactional tax matters.