With the presidential election in the books and the national headlights shining over the fiscal cliff, the real estate investment and development world are more concerned that capital gains treatment of “carried interests” is on the table of negotiations.
The developer association NAIOP describes a “carried interest” (also known as a “promoted interest” or a “promote” in the real estate industry) as a financial interest in the long-term capital gain of a project given to a project promoter or developer, from the passive equity owners or investors in the project. The carried interest is paid only if the property is sold at a profit that exceeds the agreed-upon returns to the investors. It is designed to give the developer a stake in the venture’s ultimate success. NAIOP and others are lobbying to keep capital gains treatment, but it looks like an uphill fight. As with most other tax issues, conflicting results are buried in the gritty facts of each case. Many legitimate deals support the speculative-risk argument for continued capital gains investment treatment for carried interests. But there are also clear examples in which the numbers worked into a carried-interest agreement were blatantly favorable, were given in place of income-taxed management fees, and practically guaranteed a future payout without risk, and those overreaching examples are what make carried interests an attractive political target in the budget fight. It will be interesting to watch how current and future transactions are structured to account for the unknown changes in the wind.