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PDtax, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 4026
Experience:  35 years tax experience, including four years at a Big 4 firm.
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How does income qualify as carried interest?

Customer Question

How does income qualify as carried interest?
Submitted: 3 months ago.
Category: Tax
Expert:  PDtax replied 3 months ago.

Hi from Just Answer. I'm PDtax. I'll assist.

Carried interest is a quirk in US investment fund law which allows management fees for the fund to be considered capital in nature, and not income like one would typically think of fees. Some management fees are ordinary in nature, but most are still considered carried interest.

After all, attorney fees, CPA fees, even brokerage fees are ordinary income to their recipients. Management fees paid to hedge fund management as a percentage for account management are, but the bulk of their fees, paid as participation after investors are paid, are not. Since they are often paid in shares of the funds they manage, that is considered a carried interest, or investment, for the hedge fund manager.

As such, when they sell their shares, the income they receive is taxed as capital gains. The concept considers not only the years such investments are typically held by management, but investments of their own made by management in the fund.

I hope that answers your question. if so, please rate my response using our star rating scale. Positive feedback is appreciated. I'm PDtax.

Customer: replied 3 months ago.
In this instance, my LLC (*************** LLC) put together the purchase of improved land (300 finished lots) for $2.5 Million. I brought the deal to a fund manager who had an existing fund that had invested in over 3000 lots. I nominated the fund and it acquired the lots. The fund manager provided for me to participate in 1/4 of their interest in the fund through a side letter agreement. They were required to put up 5% of the capital ($125,000) and I contributed 25% of that ($31,250). After the fund investors received a 6% return, the manager (and I) received a promoted interest equal to 20% of the remaining proceeds. The entity through which I invested is my LLC, to which my wife and I are the only members. There were no shares involved, only LLC membership interests and an agreement giving me an interest in the fund managers interest in its LLC. I received approximately $240,000 from the promoted interest. Can it be treated as capital gains?
Expert:  PDtax replied 3 months ago.

That is a very different question than the generic carried interest question you left off with. In order to protect your privacy, I will post a privateer offer to assist with the tax research.

I will also ask site management to take your post down as private information is listed.

Please review my offer and advise. Our discussion and research will be private through a private link or email.

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