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IRS Issues Final Regulations on Carried Interest
12 January 2021
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The Final Regulations provide much anticipated changes—including some welcome clarifications—to the rules set forth in the Proposed Regulations.
Although the Final Regulations continue to require that capital interest allocations be identified in the partnership agreement and books and records, the Final Regulations eliminate the much-criticized requirement that such allocations be tied to relative capital accounts.
The Final Regulations also relax a rule contained in the Proposed Regulations that prevented a capital interest funded with certain loan proceeds from qualifying for the capital interest exception. Under the Final Regulations, a loan from a partner or related person will not bar the capital interest exception from applying if such loan is fully recourse to the holder and certain other conditions are met.
The Final Regulations adopt a narrower version of the look-through rule in the Proposed Regulations for a seller of an API that has been held for more than three years. However, the Final Regulations continue to allow a carried interest recipient to recognize long-term capital gains upon the sale of an asset held longer than three years by a partnership, even if the grant of the carried interest was within three years.
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