(Read more on the debt and equity markets.)
WASHINGTON, DC-New rumblings from Congress to push for a change in the way certain private equity transactions are taxed--specifically changing the tax characterization of Carried Interest--is beginning to alarm the real estate industry. Previously these changes were seen as less likely to actually become law, if only because of the threat of presidential veto. If by some reason these bills were to become law, they were perceived--accurately or not--as being limited to private equity deals.
It has been widely reported that New York Democrat Charles Schumer is preparing new legislation that would raise the tax rate in all partnerships, not just private equity. Another new congressional proposal is to link this issue to a revamp of the widely-hated AMT (alterative minimum tax) schedule. Vetoing AMT reform, critics of the proposed law acknowledged, will be very difficult. Sen Schumer's office did not return calls from GlobeSt.com by press time.
"I wasn't as concerned when these laws were first proposed, but now it is getting scary," William H. Venema, chair in the corporate and securities practice of Epstein Becker Green Wickliff & Hall, P.C and the managing partner of the Dallas office tells GlobeSt.com. "What they are doing--linking this to a popular proposal--is politically very astute. Before I thought for certain Bush would veto a proposed rise in Carried Interest taxes, but now he may have a hard time."
Carried Interest, as many people now know post Blackstone's IPO, is the percentage of a fund or JV or limited partnership's profits that a general partner takes as compensation. Such profits are taxed at capital gains rates (15%) as opposed to ordinary income (which can be as much as 35%).
Ever since the IPO and the news of Blackstone's co-founder Stephen A. Schwarzman's $600 million payday when it went public, there have been calls from Congresspeople--and the introduction of at least two bills--to treat income received by partners for performing investment management services as ordinary income, that is, for it to be taxed at 35% instead of 15%. The spotlight has primarily been on private equity and financial firms, which would surely be affected. Of lesser notice, until now, has been the fact that these changes would also dramatically impact real estate development partnerships.
"In the real estate industry it is common for a developer to get Carried Interest," William R.Ahern, an Orange County, CA-based partner with Allen Matkins tells GlobeSt.com. "It is given to him or her as consideration in finding the deal and seeing it completed from start to finish. If a bill like this is enacted it will affect their returns and might prevent them from undertaking certain projects with a lot of associated risk."
Up until now, though there has not been much attention paid to the impact this change in law would have on real estate partnerships even though 46% of partnership returns are filed by the real estate industry, he says.
Linking these proposals to AMT reform may be the wakeup call the real estate industry needs, Venema says. "If successful, these bills could drastically change entrepreneurial activity in the real estate industry and may even be an opening salvo in a greater assault on the cutbacks in the capital gains tax."
Portions of this article appeared in Debt & Equity Journal.
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Erika Morphy
Erika Morphy has been writing about commercial real estate at GlobeSt.com for more than ten years, covering the capital markets, the Mid-Atlantic region and national topics. She's a nerd so favorite examples of the former include accounting standards, Basel III and what Congress is brewing.
