Enacted in 2017, Section 1061 provides a minimum holding period of three years for long-term capital gains for carried interests issued to certain service providers. Section 1061 treats as short-term capital gain (generally taxed at ordinary rates) the portion of gain allocated to a service provider with respect to an applicable partnership interest that has not been held for more than three years. However, even if a service provider has held an applicable partnership interest for less than three years, capital gains allocated to the holder can qualify for long-term capital gains treatment if the asset sold by the partnership was held for more than three years. Also, Section 1061(a)(2) allows the service provider to take into account capital losses from assets held for more than three years.

“Applicable partnership interest” is defined in Section 1061(c)(1) as any interest in a partnership that, directly or indirectly, is transferred to or held by a taxpayer in connection with the performance of services in any applicable trade or business. Applicable partnership interest does not include (i) any partnership interest held by a corporation or (ii) any capital interest that entitles the taxpayer to share in partnership capital commensurate with the amount of capital contributed or the value of the interest subject to tax under Section 83 upon the receipt or vesting of the interest. Section 1061(c)(4).

“Applicable trade or business” is defined in Section 1061(c)(2) as any activity conducted on a regular, continuous, and substantial basis that consists, in whole or part, of (i) raising or returning capital and (ii) investing in, disposing of, or developing specified assets or identifying specified assets for investment or disposition. “Specified assets” is defined in Section 1061(c)(3) as (i) securities, (ii) commodities, (iii) real estate held for rental or investment, (iv) cash or cash equivalents, (v) options or derivative contracts with respect to any of the foregoing categories of assets, and (vi) an interest in a partnership to the extent of the partnership’s proportionate interest in any of the foregoing categories of assets.

Thus, Section 1061 provides that service providers who receive applicable partnership interests generally must hold the interests for a minimum of three years to obtain the long-term capital gain benefit that for other assets is available after a holding period of only one year pursuant to Section 1222. The provision targets profits interests in hedge funds, private-equity and venture-capital funds, real estate funds, and other investment partnership. Congress viewed such use as problematic because long-term capital gain treatment was available to a service provider after holding a profits interest for only one year.

John G. Hodnette is an attorney with Fox Rothschild, LLP in Charlotte.

May 19, 2025/by TAX