By Keefe Borden
A proposed change to tax laws for partnerships has drawn stiff opposition from two advocacy organizations for builders. H.R. 1068, otherwise known as the Carried Interest Fairness Act of 2021, would boost taxes on real estate by requiring carried interest to be classified and taxed as ordinary income rather than as a capital gain.
The bill was filed last week by Rep. Bill Pascrell (D-N.J.) and five cosponsors: Andy Levin, (D-Mich), Katie Porter (D-Calif), Donald Beyer (D- Va), Thomas Suozzi (D-NY) and Earl Blumenauer (D-OR).
The proposed legislation is essentially a repeat of a previously failed attempt two years ago to reclassify carried interest as ordinary income rather than capital gains. Carried interest is a share of profits from a real estate venture that general partners receive as compensation regardless of whether they contribute any initial funds.
Under current law, if the income paid out as the carry is classified as a capital gain, it generally has a maximum rate of up to 23.8%. In 2017, Congress increased the holding period required to qualify for long-term capital gains treatment as a carried interest from one to three years.
The National Association of Home Builders (NAHB) opposes the change because it would raise taxes on the multifamily housing industry and on real estate investment partnerships. The financial services industry and the real estate industry both regularly uses carried interest as a tool to encourage investment and motivate performance.
The NAHB expects both carried interest and capital gains in general to come under scrutiny in a Democratic-controlled Congress. President Biden has called for increasing the long-term capital gains and qualified dividend rate for taxpayers with income in excess of $1 million to the ordinary income tax rate and to increase the maximum ordinary income tax rate from 37% to 39.6%.
The National Multifamily Housing Council (NHMC) has not issued a statement on the latest bill to change the tax structure for carried interest, but it has clearly opposed the idea in the past. The change would hurt the apartment industry as well as the entire real estate industry. Just under 50% of all partnerships are real estate-related, it said.
The advocacy organization opposed the 2017 tax reform to extend the holding period from one year to three, arguing that real estate development carries considerable financial risks and investors need an incentive to encourage innovation and entrepreneurship.
Carried interest, also called a “promote,” has been an important part of real estate investment partnerships for years. Managing partners in a real estate partnership receive a carried interest, or a share of profits once an asset is sold. The payment is a recognition for the value they have created with the venture and the risks they took on. It pays for management expertise and compensates for initial capital contributions, the NMHC said.