Carried interest impact reassessed as new IRS rule sparks renewed analysis

The U.S. Internal Revenue Service’s newly proposed regulations on carried interest are attracting scrutiny of industry experts, who are trying to formulate long-term advice on the redrawing the short-term capital gains map. At the end of July, the Treasury Department published proposed regulations on the “three-year carry rule.” The proposed regulations have been set up to offer insight over areas that were left open to interpretation since the enactment of legislation commonly referred to as the Tax Cuts and Jobs Act in 2017. The new regulations stipulate that if an asset generating gains has a holding period of three years or less and is recognized with respect to a partnership, it can be considered a short-term capital gain rather than a long-term capital gain. The tax implications, experts say, may have some impact on how funds invest. The proposed regulations would affect investment funds, including private equity and alternative asset funds (including hedge, real estate, energy, infrastructure, and fund of funds), and the managers and general partners of these funds. Yet, there seem to be many instances where the tax implications are not clear. Such in the instance of capital interest, which is a stake that is only profitable when a capital event is triggered. As such it is not subject to the recharacterization as short-term gains, according to the IRS proposal. “The narrowness of this exception thus potentially excludes from its scope any interest in a partnership whose partners participate differently in partnership assets, such as a partnership with excuse rights or side-pockets or a GP partnership whose members have differing interests in GP capital and carry,” wrote staffers at Ropes & Gray in a recent memo on the IRS regulations. A 60-day period is being provided for public comments and requests for a hearing. Until then, law firms and auditors are pouring over the fine print for any potential for greater confusion or unintended consequences that could impact their clients.

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