Carried interests, partnership interests held in connection with the performance of services, will undergo significant reporting and taxation treatment this year. When Section 1061 was added to the tax code as part of the Tax Cuts and Jobs Act (TCJA) of 2017, there were many questions and concerns requiring clarification. Essentially, the TCJA legislation extended the holding period for partnerships participating in certain long-term capital investments from one year to three years to qualify for favorable long-term capital gains treatment. This includes investments in securities, real estate partnerships, and trusts. In January of 2021, regulators published the final regulations in the Federal Registry, resolving some of the concerns raised in earlier versions of the proposed regulations. Beginning in November 2021, the IRS issued frequently asked questions to clarify compliance questions. According to the IRS, owner taxpayers (partnership investors) and passthrough entities need to comply with these final regulations when addressing their 2021 tax compliance reporting. The following are highlights of those compliance requirements:
- 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.
- 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.
- 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.
- 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.
- Taxpayers with unrecaptured 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.