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Carried Interest Tax Hike Coming?

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There's been some sentiment out there for years that carried interest--which is currently taxed at 15 percent--should be treated like ordinary income and subject to higher tax rates. There's been some movement in Congress on it, but typically it's been defeated in the Senate.

The movement to tax carried interest has been the product of anti-private equity and hedge fund sentiment since those entities are subject to the lowered tax rates. Warren Buffett in 2007 famously blasted the tax system for enabling him to pay a lower tax rate than his secretary and his cleaning lady. That's partially a result of the carried interest tax. Similarly, the movement to push this specific tax reform started in 2007--at the peak of the private equity buyout frenzy.

So it's not a reform aimed necessarily at commercial real estate, but it nevertheless will have a deep impact on the industry. Most partnerships that will be affected will be real estate partnerships, not hedge funds. So commercial real estate trade groups have fought this tax for years. In fact, ICSC wrote about its efforts to fight the tax just last week.

But according to a Bloomberg piece, Congress may have the votes necessary to make the tax hike a reality. That spells trouble for all sorts of commercial real estate limited partnerships.

Is there any chance to stop this?

“They're using live ammunition,” said Jeffrey DeBoer, president of the Real Estate Roundtable, which, along with the National Venture Capital Association and Private Equity Council, is trying to stoke Senate opposition to the House plan.

Passage would be a reversal of fortune for the investment partnerships that in 2007 helped quash a plan to target carried interest, or the share of profits paid to fund executives. That share now qualifies for the 15 percent capital gains rate. The new proposal would tax the income as wages, with a top rate of 39.6 percent plus up to 3.8 percent in Medicare taxes.

Senate Finance Committee Chairman Max Baucus said “there is a certain sense of inevitability” that a higher levy on carried interest will be included in a broader bill.

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Senate Budget Committee Chairman Kent Conrad said lawmakers are considering the tax increase to help fund a $180 billion measure to renew tax breaks for businesses and extend a program that subsidizes local bond sales, as well as help both the jobless and doctors facing Medicare cuts. The tax would generate about $20 billion, the North Dakota Democrat said.

“There is a growing chance that something with carried interest will be included,” he said.

The partnerships are pushing back and have made some headway. Four Senate Democrats and Massachusetts Republican Scott Brown sought a waiver for venture capital funds from the tax increase. Real estate and venture capital groups are holding meetings on Capitol Hill in an effort to persuade lawmakers that they create jobs and that penalizing fund executives would impede growth in their industries.

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White House Budget Director Peter Orszag on May 12 predicted the Senate will pass changes to the tax treatment of carried interest “within the next few weeks.” President Barack Obama sought the change in each of his first two budgets.

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“Policymakers are starting to understand that this is not a hedge fund bill that tangentially affects other businesses,” DeBoer said. “It is a real estate tax increase bill that tangentially affects hedge funds.”

The proposed tax increase passed the House again in June 2008 and last December, each time getting nowhere in the Senate.

The U.S. had 3.1 million partnerships in 2007, according to IRS statistics. Some 1.5 million were real estate partnerships. Finance and insurance partnerships totaled 308,307, of which 8,981 were hedge funds. The rest include industries such as farming and construction.

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Elaine Misonzhnik

Senior associate editor Elaine Misonzhnik has been writing for National Real Estate Investor since June 2006 and has covered commercial real estate for more than 12 years. She first became...
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