Private Equity and Hedge Fund Professionals Need to Heed Final IRS Rules on Three-Year Holding Period Applicable to Carried Interests

March 18, 2021 - The Tax Cuts and Jobs Act imposed a three-year holding period on “carried interests,” which limits the ability of private equity, hedge fund, and other investment professionals to be taxed at long-term capital gains rates generally on the sale of the portfolio assets that their funds invest in.  

The Internal Revenue Service recently issued final regulations on how to apply the three-year holding period. Proposed regulations were issued in July 2020 (please see our prior alert here), and private equity and hedge fund professionals need to be mindful that the new three-year holding period primarily applies to the gain or loss on:  

• sales of their carried interests; and
• distributions or allocations of gain they receive from the sale of a fund’s portfolio assets.

Although the three-year holding period for carried interests has been in effect for several years, the final regulations will generally only apply to tax years beginning on or after January 19, 2021. However, investment professionals may choose to rely on them for tax years beginning after 2017, as long as they do so consistently.

The following client alert covers the following:  

• In what situations does the three-year holding period apply?
• Who does the three-year holding period apply to?
• How to apply the three-year holding period.