IRS Issues Final Regulations on Carried Interest

12 January 2021
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Key takeaways:
  • 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.