The IRS has issued proposed regulations on the treatment for a partner that holds interest in a partnership that is transferred to or held by a taxpayer in connection with the performance of substantial services in an applicable trade or business, known as an applicable partnership interest (API). This guidance is issued based on the law enacted by the Tax Cuts and Jobs Act, known as the carried interest rules. The regulations include the capital gain treatment and the recharacterization rules, holding periods and allocations, the active trade and business tests, and the reporting of for the transfer of an API.
Background on an API. An API is any interest in a partnership held in connection with the performance of substantial services by the taxpayer or by any other related person, in an applicable trade or business. The guidance contains tests to determine if the business activities qualify as an active trade or business. Additionally, certain types of transactions are excluded from the definition of API.
Capital gain or loss recharacterization and holding periods. Generally, the required holding period to obtain the lower long-term capital gains tax rate was one year for all partnership interests and partnership assets. However, under the new provisions, the required holding period for an API must be greater than three years to obtain long-term capital gains treatment. For individual taxpayers, short-term capital gains are taxed at the ordinary income rate whereas long-term capital gains are generally taxed at a lower rate. Additionally, taxpayers must determine whether the gain or loss is factored into this recharacterization amount and this depends on the holding period of the API.
API gains and losses exclude certain types of transactions which were already held for more than three years as of January 1, 2018 and certain type of gains.
Contact the Crosslin tax team at (615) 320-5500 to review the impact of this guidance on transfers as a partner or partnership with an applicable partnership interest to determine the impact on your taxable income. We are here to help!