BOMA International supports maintaining current law that taxes the “carried interest” of a general partner in a real estate partnership as a capital gain. BOMA International opposes altering the tax code to require carried interest be taxed as ordinary income.
Real estate is a long-term, risk–based investment which is regularly structured as a partnership, and therefore often involves a component known as “carried interest.” The partnerships are made up of limited partners and general partners. The limited partner(s) provides the money and capital, has very little say in the operation of the investment and is simply looking for a particular return on the investment. The general partner(s) brings the “sweat equity” to the investment and does the day-to-day work making sure the property is properly managed and is compensated by a flat fee that is taxed as ordinary income. They are also offered an additional percentage of the profits as incentive to make the investment prosperous without contributing any capital of their own; this compensation is what is known as “carried interest.” When the general partner receives the “carry” it is taxed as a capital gain. It is paid only when, and if, the real estate investment actually is successful.
Requiring that all returns from carried interests be taxed at ordinary income rates, regardless of the nature of the investment or the investment period, as some in Congress have proposed, will disrupt the investment relationship between entrepreneurs and their capital finance partners.
In addition, pension funds, endowments, charities and universities are typical investors in real estate. General partners will demand a greater share of the return to compensate for the increased tax. This means returns to the investors will diminish, affecting capital flow to real estate and other investments. Fewer deals will be done.
A change in the tax code requiring carried interest be taxed as ordinary income would also more negatively impact the small real estate entrepreneurs who may not have the same negotiating leverage as larger firms to pass on a carried interest tax increase to their investors or employ new investment structures to avoid the tax altogether.
In both 2007 and 2008, the House passed legislation that included the tax increase on carried interest to help offset the cost of legislation to patch the alternative minimum tax (AMT) for one year; however, on neither occasion did the Senate seriously consider the bill as drafted. The issue resurfaced in 2009 in President Obama’s budget as well as Rep. Sander Levin’s (D-Mich.) bill, H.R. 1935. In December 2009, a carried interest tax increase passed the House to offset the cost of some tax breaks known as the “extenders” package, which include a one-year extension of the 15 year depreciation period for leasehold improvements. Subsequently, in 2010 the Senate attempted and failed on three occasions to pass legislation offsetting the cost of the extenders package with a tax increase on carried interest. At the time of publication, carried interest remained at the capital gains tax rate. In 2011, President Obama introduced The American Jobs Act, a bill that was aimed at helping stimulate a struggling economy. Once again, carried interest was included as a revenue offset to temporary tax changes. At the time of publication, no action had been taken on the bill.