Carried Interests Undergo Significant Tax Treatments in 2024

In January 2021, regulators published the final regulations in the Federal Registry, resolving some of the concerns raised in earlier versions of the proposed regulations.

Starting in November 2021, the IRS issued frequently asked questions to clarify compliance issues.

According to the IRS, owner-taxpayers (partnership investors) and passthrough entities need to comply with these final regulations when addressing their tax compliance reporting. Here are the highlights of those compliance requirements:

1. 1️⃣ A passthrough entity is now required to attach Worksheet A along with their Applicable Partnership Interest (API) holders Schedule K-1 after December 31, 2021. The worksheet discloses one-year and three-year holdings gains and losses. For regulated investment companies (RIC) and real estate investment trusts (REIT), reporting information will be disclosed on Form 1099-DIV.
2. 2️⃣ For tax reporting after December 31, 2021, Owner-Taxpayers (aka investors in the partnership) will now use the information filed by the passthrough entity to complete IRS Worksheet B, as well as IRS Form Table 1 and Table 2, and attach those forms to their annual tax return.
3. 3️⃣ If a taxpayer does not hold a qualifying investment for the three-year minimum, the investment will be treated under short-term capital gains rules. The IRS calls that calculation recharacterization. Refer to Worksheet B for that calculation.
4. 4️⃣ For reporting, taxpayers should note the recharacterization on Schedule D, as well as on Form 8949: Sales and Other Dispositions of Capital Assets, when submitting a 1040 or 1041.
5. 5️⃣ Taxpayers with unrecaptured Section 1250 gain, gains from the sale of real property such as a commercial building, warehouse, or rental property, should also utilize Worksheet B and report the amounts on Schedule D of their tax return.