Taxation of Carried Interest
If you make your living from a carried interest in a fund, you’ve heard of the three-year rule…
Unlike normal investments, which have a one-year period in order to be taxed at favorable long-term capital gain rates (20%, federal), if you’ve held your investment for less than three years, you get taxed at the short-term capital gain rates (37%, federal).
Kind of.
It turns out that, like most things tax related, the devil is in the details. Technically, the three-year rule keys off of the holding period of any capital assets sold in an exit transaction.
That leaves two rather large loopholes to plan into:
If you can allocate gain recognized to assets other than capital assets, the three-year rule does not apply.
If you invest into a pass-through entity with a greater than three year holding period in assets, when the entity sells the assets, the gain that flows through to you will not be subject to the three-year rule.
These two loopholes provide opportunities for nearly any investor to avoid the three-year rule if they prepare for a disposition at the time of the initial investment. Acta Consulting helps to structure acquisition transactions with an eye towards ultimate disposition, preparing for the possibility that that disposition will be within three years.
