Carried Interest Inches Closer In Congress

WASHINGTON, DC-Signs that carried interest’s tax characterization will indeed be changed by Congress are growing–the latest indication came from Senator Charles Schumer, who recently told reporters it was “on the table.”

Carried interest is the percentage of a fund, joint venture or limited partnership’s profits that a general partner takes as compensation. Many real estate partnerships are structured around this concept, with developers taking much of their compensation this way in lieu of a salary. These proceeds are taxed at the capital gains tax rate of 15%. Changing that characterization to ordinary income would essentially triple the tax rate.

The next 30 days are a crucial period for this measure on the Hill,according to an earlier interview with Real Estate Roundtable’s JeffDeBoer. Congress is now considering, as it does every year, about a dozen or so tax proposals that, bundled together are called the Extenders package.

Last year ended without Congress passing this Extenders package.However, the House passed its version and then used the change tocarried interest as a funding source. The Senate also passed itsversion, but without the carried interest proposal. Instead, it paidfor the Extenders package with other sources. Unfortunately, thosesources are being used to finance the health insurance overhaul,DeBoer said. “What we have now is a situation where the House bill on tax extenders needs to be conferenced but the revenue sources in the Senate bill are gone,” he told GlobeSt.com. “The temptation to adopt the House provisions on carried interest will be significant.”

If this does happen, says Harold Levine, chair of the tax practice atNew York City-based law firm Herrick, Feinstein, it will have a grimimpact on real estate partnerships. “The math as to the effect on services partnership interests is simple, if disturbing,” he tells GlobeSt.com. “If the effective tax rates and the tax liability on carried interest double as they apparently will, the fundamentals of the underlying joint ventures have to be that much more appealing to the service partners to compensate for the additional tax burden being levied on them by the government.” In a down market, it’s difficult enough to make commercial deals pencil out well enough to attract investment interest without unfavorable changes in the tax treatment of the joint ventures, he says.

Levine also points out that the proposal remains murky in manyrespects and does not address the specifics as to whom it willeventually apply. “So it’s the worst of both worlds for real estatejoint ventures,” Levine concludes. “The only certainty you have–assuming this gets traction and becomes written in stone–is that akey tax rate will double. And there’s plenty of uncertainty regarding how this would interact with several other provisions governing compensation for partnership service. And if there are two things the commercial real estate market hates, it’s higher taxes anduncertainty.”