Senate Dems Drop MBA/Trade Group-Opposed Carried Interest Provision in Reconciliation Bill

Senate Democrats late Thursday dropped a controversial carried interest provision in a reconciliation bill that the Mortgage Bankers Association and other industry trade groups said would “cripple the housing recovery.”

On July 27, Senate Majority Leader Chuck Schumer, D-N.Y., and Sen. Joe Manchin, D-W.Va., announced an agreement to add the Inflation Reduction Act of 2022 to the FY2022 budget reconciliation bill and vote in the Senate. The proposed legislation would have expanded the scope of Section 1061.1 which outlines taxation of carried interests and other partnership interests.

However, Sen. Kyrsten Sinema, D-Ariz., objected to the carried interest provisions of the bill, leading to intensive negotiations on Thursday, news sources reported. With Democrats holding a razor-thin 50-50 edge in the Senate (Vice President Kamala Harris serves as tiebreaker), Sinema’s objections threatened to derail the overall reconciliation bill. Late Thursday, after discussions with Sinema, Schumer and Manchin agreed to drop the the carried interest provision from the 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 told The Hill. She said she would vote to begin debate on the bill, subject to the Senate parliamentarian’s review.

Earlier on Thursday, MBA and more than a dozen industry trade groups sent a letter to the Senate, opposing the carried interest provision. The MBA/trade group letter said the carried interest provisions of the Inflation Reduction Act of 2022 which would “harm the residential and commercial real estate industries to the overall detriment of job creation and the economy. The carried interest proposal would slow housing production, discourage the capital needed to reimagine buildings to meet post-pandemic business needs, hamper job creation and create an additional unknown in an already confusing economic environment. The small amount of revenue associated with the proposal is not needed in this inflation-fighting legislation and we respectfully urge that it be dropped.”

The letter cited three primary concerns:

–Holding period measurement. The legislation would unintentionally extend the holding period requirement well beyond the 3 or 5 years suggested in the bill’s description. “Some real estate assets that are held for 8 years, 10 years, or even longer would not qualify for long-term capital gains treatment,” the letter said. “This is because the holding period would not start until a partnership had acquired substantially all of its assets. In the case of an open-ended fund that has no predetermined end date, it may never meet the holding period’s ‘substantially all’ requirement.

As a result, the letter said, the bill would greatly distort and misalign the interests of general partners vis-vis limited partners who are not subject to these arbitrary rules. It would drive the potential for new and unnecessary conflicts between parties. In addition, the holding period changes would unfairly deny capital gains treatment to the income that arises from many productive, long-term investments simply because of the owners’ partnership structure. The fact that a partnership invests in more than one building or business should not distort the basic economic reality and longstanding principle that each asset is taxed ad its own capital investment with its own lifespan and holding period.

–Extension to section 1231 gain common in housing and other real estate projects. The pointes out the legislation, perhaps unintentionally, would extend the holding period requirement to other types of carried interest income common in the construction and improvement of housing and other real estate. Specifically, the expanded carried interest rules would pull in section 1231 gain —net gain from property used in a trade or business or held for the production of income.

The letter noted the Section 1231 gain was excluded from the regime when it was enacted in 2017. “Many real estate funds construct or rehabilitate housing and sell it within two years so they can finance the next housing project,” the letter said. “Extending the 3-year holding period will slow down their housing development as funds hold on to the property for another year, or it likely will drive up rents on the property to recuperate the additional tax liability. The proposed change is counterproductive to addressing the severe housing and crisis throughout the country.”

–Retroactivity. The legislation would apply retroactively to partnership agreements executed years earlier. In some cases, the result would be to change the tax rate for one partner to the agreement and not the others. “This could alter the basic and mutually agreed economics of the original deal between the parties, and further undermine the predictability of the tax system,” the letter said.

“Carried interest is a vital tool contributing to capital formation and new housing development, productive risk-taking and job creation,” the letter said. “Changes to carried interest could have profound, unintended consequences for the main streets of cities all across our country. Property taxes on real estate contribute 75 percent of local tax revenue and provide a stable and reliable source of funding for vital public services like education and law enforcement.

“Achieving tax fairness is complicated,” the letter noted. “Simple solutions often are not solutions at all. Now is not the time to impose a tax increase on the countless Americans who use partnerships to develop, own and operate housing and other commercial real estate. We urge you to preserve current tax law as it relates to carried interest.”

Joining MBA in the letter: American Resort Development Association; American Seniors Housing Association; Building Owners & Managers Association; CCIM Institute; CRE Finance Council; ICSC; Institute of Real Estate Management; NAIOP, the Commercial Real Estate Development Association; National Apartment Association; National Association of Home Builders; National Association of Realtors; National Multifamily Housing Council; The Real Estate Roundtable; and the Realtors Land Institute.