On July 31, 2020, the IRS and the Department of the Treasury issued proposed regulations under IRC Section 1061 for taxpayers that hold an applicable partnership interest (API) in connection with the performance of services. The rules, commonly known as the carried interest rules enacted as part of the Tax Cuts and Jobs Act of 2017, require that taxpayers use three years as the holding period threshold for calculating long-term capital gain, rather than one year for APIs. Gain with respect to APIs held three years or less is treated as short-term capital gain.

Among other things, the proposed regulations address capital gain dividends paid by RICs and REITs.  RICs and REITs pay net capital gain dividends to shareholders that are generally treated as long-term capital gain by RIC and REIT shareholders. If a RIC or REIT is held by a partnership, the regulations provide that the carried interest rules apply to RIC and REIT capital gain distributions.

For taxpayers with APIs to comply with the carried interest rules, the proposed regulations allow RICs and REITs to disclose the amount of the capital gain distribution that is not subject to the carried interest rules. RICs and REITs may also disclose the amount of capital gain distribution that would meet the three year holding period requirement for a shareholder with an API. The RIC or REIT would provide these amounts as part of their required annual written communication to shareholders. These amounts must be calculated pro rata for all shareholders.

Taxpayers with an API would then use the two additional disclosure amounts in their calculations as required under the carried interest rules. The proposed regulations do not require these additional disclosures. However, if a RIC or REIT does not make the disclosures described above, the entire amount of the capital gain distribution would be treated as a one year amount — being treated as short-term capital gain rather than long-term — by a taxpayer subject to the API rules. Additionally, if a taxpayer with an API incurs a loss on sale or exchange of RIC or REIT shares that the taxpayer held six months or less, any capital gain distributed by the RIC or REIT and disclosed as a three year amount (i.e. long term) will be treated as a one year amount (i.e. short term).

Taxpayers who hold RIC or REIT shares through a partnership interest in connection with the performance of services should consider the impact of these proposed rules. Sponsor RICs and REITs should consider the appropriateness and process of providing this information to investors. It is important to note the regulations are not final; the IRS and Treasury will accept comments on the proposed regulations for a 60 day period.

Contact Jay Laurila at jlaurila@cohencpa.com, Rob Velotta at rvelotta@cohencpa.com or a member of your service team to discuss this topic further.

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.