IRS Finalizes Carried Interest Regulations

On January 7, 2021, the IRS and Treasury issued final regulations under section 1061 of the tax code. Section 1061 imposes a three-year holding period as a precondition to recognizing long-term capital gains on carried interests issued to investment professionals, and otherwise treats the capital gains as short-term capital gains. Individuals are taxed at preferential rates on long-term capital gains, but not on short-term capital gains.

The final regulations largely adopt proposed regulations that were issued in July 2020 (which we discussed here) while making some taxpayer-favorable changes, including:

• Expansion of capital interest exception. The final regulations reduce the situations under which section 1061 would recharacterize gains from invested capital as short-term capital gains.