Under current law, the carried interests (or profits interests) of general partners in real estate partnerships are taxed at capital gains rates (currently 15%) when the property is sold. In 2008 and 2009, the House passed legislation that changed the rule so that carried interests in real estate partnerships (and many other investment arrangements, as well), would be taxed as ordinary income. This provision has been very controversial. Until last week, the Senate had been unwilling to adopt this far-reaching legislation. Now, the chairs of the tax-writing committees have agreed that carried interest will be among the provisions used to "pay for" a very large package that will extend expired tax provisions and various spending programs, as well.

Under the compromise, a portion of the amount realized from a carried interest will be taxed as ordinary income and the remainder will be taxed as capital gains income. During 2010, 2011 and 2012, 50% of the income will be taxed at ordinary rates and 50% will be taxed at capital gains rates. Beginning in 2013, 75% of the carried interest income will be taxed as ordinary income and 25% taxed as capital gains. Assuming that the Bush tax cuts expire for upper income individuals, this would mean that, by 2013, the highest tax rate on carried interests would be 35%. Note that general partners who have invested their own capital in a real estate partnership will not be affected by this change.

The carried interest provision is part of H.R. 4213, a package that would renew and extend many expired tax provisions through December 31, 2010 and that would also extend spending programs including unemployment insurance benefits and various Medicare payment structures. The House had been scheduled to vote on the measure May 21, with the Senate following the week of May 24. The House did not conduct that vote, however, so the timing has slipped. It is not known if the legislation can clear both bodies before the Memorial Day break.