Carried Interest Loophole Survives, Tax Hike Dropped from Bill

That whooshing sound you’re hearing is the sigh of relief from real estate investors reacting to the news that the carried interest loophole—the favorite tool of CRE investors to mitigate their federal tax burden—has survived the final negotiations on a $740B tax and spending bill moving to a vote in the US Senate today.

The original language of the reconciliation bill, sponsored by Sens. Chuck Schumer and Joe Manchin and branded as the Inflation Reduction Act, would have closed the loophole and increased the tax on transactions involving properties held for less than three years to 37% from the current level 23.8%.

The provision in the original bill would have required gains of a partnership interest to be held for a minimum of five years in order to be taxed as a long-term capital gain rather than the much higher tax rates that apply to short-term gains.

With the US Senate split 50-50 between Democrats and Republicans, Sen. Kyrsten Sinema of Arizona—the last holdout among the Democrats—demanded that the provision altering the carried interest loophole be dropped from the bill before she agreed to provide the vote needed to pass it, saying that it would stifle corporate competitiveness.

Last night, Schumer agreed to Sinema’s conditions—which also reportedly included $5B in emergency drought relief for the parched Southwest—and she announced that she would vote in favor of the reconciliation bill.

“We have agreed to remove the carried interest tax provision, protect advanced manufacturing and boost our clean energy economy in the Senate’s budget reconciliation legislation,” Sinema said, in a statement released Thursday night.

While the carried interest loophole lives to fight another day, CRE investors probably should wait before they do a victory dance: Sinema signaled in her statement that Senate Democrats will continue to work on reforms to the tax code that may include alterations of the carried interest loophole.

“Following this effort, I look forward to working with Sen. [Mark] Warner to enact carried interest tax reforms, protecting investments in America’s economy and encouraging growth while closing the most egregious loopholes that some abuse to avoid paying taxes,” Sinema said.

Elimination of the carried interest loophole would have generated an estimated $14B in new revenue. As part of his agreement with Schumer on the reconciliation bill, Manchin required that the $370B in spending on climate and energy programs in the bill be offset by an equal amount of deficit reduction through increased taxes.