Recent Developments in Carried Interest Taxation: What Real Estate Investors Need to Know

February 25, 2025 | Author:  David J. Murphy

Recently, the taxation of carried interest has once again become a focal point of national tax policy discussions, with potential significant implications for real estate developers and investors.

What Is Carried Interest in Real Estate?

In real estate partnerships, carried interest (often called a “promote” or “profits interest”) is the general partner’s share of profits above a specified return threshold. Unlike management fees that compensate for routine services and are taxed as ordinary income, carried interest rewards the general partner for:

• Creating additional value in the investment
• Contributing specialized expertise, business acumen, and industry relationships
• Taking on financial and legal risks as the managing partner

Typically, the limited partners (investors) receive their initial investment back plus a preferred return (often 6-8%), after which the general partner (developer) receives a percentage of remaining profits (commonly 20%) as carried interest. Currently, this carried interest is eligible for long-term capital gains tax treatment if held for at least three years.

What’s Happening

President Trump has called on Congress to close what he referred to as the “carried interest tax deduction loophole,” prompting Democratic senators including Tammy Baldwin (D-WI), Elizabeth Warren (D-MA), and Bernie Sanders (I-VT) to reintroduce the Carried Interest Fairness Act. This legislation would reclassify all carried interest as ordinary income rather than capital gains.

What This Means for Real Estate Investors

While often portrayed in media as affecting only hedge fund managers and Wall Street executives, changes to carried interest taxation would impact real estate partnerships of all sizes:

• General partners in real estate ventures could see their carried interest taxed at ordinary income rates (up to 37%) instead of the lower capital gains rates (currently 20%)
• Increased tax burden could affect cash-poor entrepreneurs who maintain ownership interests in their developments
• Housing affordability might be negatively impacted as increased costs are potentially passed on to renters and buyers

Current Status

It’s important to note that the Tax Cuts and Jobs Act of 2017 already extended the holding period required for carried interest to qualify for long-term capital gains treatment from one year to three years.

Industry groups including Americans for Tax Reform have mobilized against the proposed changes, arguing that the current tax treatment of carried interest incentivizes risk-taking and entrepreneurship that benefits investors, pension funds, and retirees.

Looking Ahead

While the budget debate moves forward, it will likely be several weeks or months before the tax-writing committees mark up and vote on the actual details of any tax legislation. Our firm continues to monitor these developments closely and will provide updates as the situation evolves.

David J. Murphy is the managing attorney of the law firm of Murphy PC in Boston, Massachusetts.  He regularly represents real estate developers and investors in real estate development projects.