What is Carrying Interest and How Does it Work?

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Undoubted interest part of the profits of a private equity, venture capital or hedge fund that is paid as an incentive compensation to the general partner of the fund, but only upon reaching a certain minimum income. In addition to this, the amount is usually 20%.

In this sense, carry-forward interest is usually treated as a long-term capital gain that is taxed at a lower rate than ordinary income.

Conditional profit

Please note that the interest carried over can also be canceled if the fund is not operating.

Also, if a fund performs well but then falls behind, the general partner may have to pay back some of the interest already earned to make up for lower returns.

Another point to consider is that investments held for more than three years are subject to long-term capital gains tax at a maximum rate of 20%, compared to a maximum rate of 37% for ordinary income.

tax loophole

In this light Tax cuts and the Jobs Act 2017 increased the minimum investment holding period from one year to three years to ensure that the associated interest is treated as long-term capital gains.

It should be noted that some funds charge higher than average interest rates, sometimes up to 30% of the fund’s total earnings. These higher rates are referred to as “super carryover”.

Thus, for some individuals, accrued interest is a tax loophole, as fund managers often pay low tax rates, regardless of the fact that they are the main source of remuneration for the general partner.

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