Long awaited carried interest regulations answer some questions

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August 2020

Overview

Treasury and the IRS on July 31 released proposed regulations under Section 1061. That provision which was enacted in the 2017 tax return legislation, generally increases the holding period to qualify for long-term capital gain related to certain partnership interests (such as carried interests held by managers in the financial services industry). When applicable, the greater than one-year holding period generally needed for long-term capital gain treatment is increased to a greater than three-year holding period. The increased holding period under Section 1061 applies to both gain on the sale of the applicable partnership interests and on partnership gain allocated to partners holding applicable partnership interests. 

The proposed regulations generally apply beginning on or after the date final regulations are published in the Federal Register; however, taxpayers may rely on the proposed regulations for tax years beginning before final regulations are published. This Insight provides a high-level summary of the proposed regulations. As described below, the proposed regulations define key terms, describe the method for calculating the amounts subject to Section 1061, provide rules for applying Section 1061 through tiers of passthrough entities, detail the application of the exceptions to Section 1061, provide reporting rules, and describe rules for transfers to related parties.

The takeaway

These long-awaited regulations answer many, but not all, of the questions raised by Section 1061. Fund managers should review with their advisors the impact of the proposed regulations. Managers considering the monetization of their business will want to carefully consider the timing and structure of how that takes place. Further, managers may want to consider plans for availing themselves of the capital interest exception, modifying legal documents to conform to the carry waiver provisions, and review any existing estate or gift tax planning in effect.

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Audrey Ellis

Principal, M&A Tax, PwC US

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