Navigating IRS Carried Interest Regulations: Significant Tax Rules and Planning Opportunities

IRC Sec. 1061 increases the holding period required for long-term capital gains treatment in respect of “carried interests” (also referred to as profits interests) from more than one year to more than three years. The impact of the three-year holding period could be burdensome to hedge funds, private equity, and real estate fund managers.

There is controversy over carried interest because the tax rules allow hedge funds, private equity, and real estate professionals to pay U.S. federal income tax on carried interest allocable to long-term capital gains at the favorable long-term capital gains tax rate instead of the higher tax rate applicable to compensation income or income for services. IRC Sec. 1061 in effect increases the required long-term capital gains holding period with respect to an "applicable partnership interest" from more than one year to more than three years. The definition of an “applicable partnership interest” is designed to capture “carried interests,” i.e., interests in partnerships granted to individuals in connection with the performance of substantial services by the taxpayer or a related person, which are to be distinguished from “capital interests” that are granted to individuals for invested capital. Advisers must identify interests subject to IRC Sec. 1061 for tax planning purposes.

In 2021, the IRS and the Treasury issued final regulations applicable to IRC Sec. 1061 which include certain significant changes to the proposed regulations issued in 2020. The final rules include revisions to (1) the “capital interest” gains and losses and exceptions, (2) the applicability of IRC Sec. 1061 to gains on the sale of API and distributed API property, and (3) transfers of APIs to related parties in a nonrecognition transaction. Tax counsel and advisers must identify critical issues stemming from these regulations and plan accordingly.

Listen as our panel discusses the requirements of IRC Sec. 1061, determining API subject to the holding requirements, key planning issues for IRC Sec. 1231 properties, and tax planning techniques to maintain favorable tax treatment of carried interest.

1. Overview of the requirements of obtaining capital gains treatment under IRC Sec. 1061
2. Impact of IRS regulations and guidance
3. Determining "applicable partnership interest" and "applicable trade or business"
4. Applicability of IRC Sec. 1061 to IRC Sec. 1231 property
5. Planning ideas for avoiding IRC Sec. 1061 three-year holding period
6. Best practices for compensation arrangements in light of holding requirements under IRC Sec. 1061

The panel will review these and other noteworthy issues:

• Treatment of carried interest and performance of services under IRC Sec. 1061, the IRS regulations promulgated thereunder and applicable guidance
• Available tax planning techniques and strategies for partnerships and fund managers for more favorable tax treatment
• Determining partnership interest that is API subject to IRC Sec. 1061
• Understanding key planning issues regarding the applicability of IRC Sec. 1061 to IRC Sec. 1231 property (including rental real estate)
• Potential planning opportunities presented by special allocations, transfers to unrelated parties, capital contributions, and distributions
• Best practices in ensuring favorable tax treatment in compensation arrangements involving carried interest

Learning Objectives

After completing this course, you will be able to:

• Understand the treatment of carried interest and performance of services under IRC 1061
• Understand critical provisions of the IRS final regulations
• Ascertain available tax planning techniques and strategies for partnerships for more favorable tax treatment
• Recognize partnership interest that is "applicable partnership interest" subject to IRC Section 1061 holding requirements
• Understand key planning issues regarding the applicability of IRC 1061 to 1231 property
• Ascertain planning opportunities presented by special allocations, transfers to unrelated parties, capital contributions, and distributions

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business, legal or public firm experience at mid-level within the organization, involved in sophisticated tax planning and reporting; supervisory authority over other attorneys/preparers/accountants. Knowledge and understanding of partnership and other pass-through entities, IRC 1061, 1231; familiarity with tax planning for hedge funds, private equity, and real estate professionals.

Strafford Publications, Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of Accountancy have final authority on the acceptance of individual courses for CPE Credits. Complaints regarding registered sponsons may be submitted to NASBA through its website: www.nasbaregistry.org.

IRS Approved Provider

Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).