Carried Interest: Policy Issue
Overview
Carried interest is a crucial tool for driving real estate investment and improving affordability long-term, spurring housing development, and promoting the growth of our built environment. Many real estate professionals use this to drive innovation and commitment, due to the considerable financial risks involved in construction.
Rental housing development partnerships generally have a sponsor or general partner that is responsible for finding and negotiating opportunities, managing assets and business operations, sourcing capital, overseeing contractors and construction, and any other day-to-day needs to make the project a success. Besides their management skills, managing partners often make initial capital contributions to the venture and take on responsibilities for recourse debt, litigation risks, and cost overruns, among other risks.
This general partner is typically rewarded with a share of the ultimate capital gain that reflects the risk they have taken and the value they contributed. This is known as a carried interest or, a “sponsor promote.”
Industry Position
Carried interest is not compensation for services like leasing or property management, which are appropriately taxed at ordinary rates. NAA supports longstanding tax law that treats a carried interest as a capital gain because of the value the general partner adds to the venture beyond services, and for risks that they take.
As an Owner or Operator, How Does this Affect My Business?
Treating carried interest as a capital gain is crucial because it reflects the return on a long-term capital asset, along with the associated risk and entrepreneurial effort. Some lawmakers want to tax a carried interest at ordinary income rates. The tax code should not limit the reward for risk-taking to taxpayers who have cash to invest. An entrepreneur who foregoes the security of a salary in order to invest their time and effort into developing rental housing that may or may not succeed should qualify for capital gains treatment the same way that a deep-pocketed and passive investor qualifies when they put their cash into a public stock or private venture.
Increasing the tax rate on a carried interest would deter real estate partnerships from investing in new construction, exacerbating the current housing shortage. With demand for apartments continuing to rise and chronic underbuilding limiting new housing supply, this change could be particularly damaging.
Contact Information
To learn more about this issue, please contact NAA's Public Policy team.