What the New GOP Tax Bill Means for Capital Interest and Investors

Back in early November, the National Real Estate Investor (NREI) published a piece  about the upcoming GOP tax bill, in which House Ways and Means Chairman Kevin Brady had talked about changing the rules governing carried interest. Now that we're closing in on a finalized bill, we look at what made it into both the House and Senate's versions of the tax bill – and what it actually means.

In the NREI article, Mr. Brady had initially proposed attaching a “two-year holding period” to carried interest: this would change the amount of time that an asset would have to be held from one year to two years to qualify for a lower tax rate. The so-called carried interest loophole is something that is frequently brought up in tax debate, and even by the president himself during the 2016 campaign. Carried interest is a tax break utilized by a variety of investment managers – from hedge fund managers, to venture capitalists, to real estate investors. The NREI article defines carried interest itself as: “the portion of an investment fund's profit -- usually a 20% share -- that is paid to investment managers.” When the asset is held for more than a year under current law, this income is treated as capital gains and not as standard income, making it eligible for a much lower interest rate. A 23.8% tax rate is what an investor would pay for income earned under the carried interest law, while standard income's highest tax rate comes in at 39.6%.

Thus with the president himself promising to “close the carried interest loophole” and the tax bill looming, many were unsure what might lie ahead. Back at the beginning of November, Mr. Brady had mentioned doubling the time that an asset must be held to qualify for the lower tax rate. He told CNBC at the time that it would hopefully keep the carried interest income focused on what he called “long-term, traditional real estate deals.” Yet after the House bill reveal, we saw even more time added than Mr. Brady had suggested, with the bill increasing one year to three that an asset must be held to qualify for the carried interest lower tax rate.

After awaiting the Senate's version of tax reform, we now know that they too have added a three-year stipulation to the carried interest tax rate. An article that appeared in the Washington Post, claimed, though, that while the law may change it won't actually affect much; if anything, the statistics seem to show that most investment managers hold their assets longer than the one or three year mark, with six years being an average. The piece in the Post went on to say that, of the various types of investors, although hedge fund managers take a lot of heat, they really don't hold their investments long enough to qualify at all. The take-away so far appears to be that as we head toward the holiday season and perhaps a ratified tax bill, that although some things may change regarding capital interest that for all intents and purposes, they may remain the same. The investors who may soon be required to hold assets for three years to qualify for the capital interest tax rate may have always intended to hold those assets for that long or even longer; although those who did not may soon have no choice if they want to qualify for that income tax rate.

Elizabeth Wheeler