Updated · Part of the CRE investment glossary
Carried interest vs promote
Carried interest and promote describe the same economic idea: the GP gets a share of profits larger than its share of the capital. The difference is mostly usage.
In private equity, carry is usually a single rate, set in the fund agreement, paid after investors receive their capital and a preferred return, frequently in a whole-fund waterfall with a catch-up. In real estate syndications and many real estate funds the same right is called the promote. It is more often paid deal by deal and stepped up in tiers as returns rise.
Both are set by the partnership or operating agreement. Carry is not guaranteed: if the deal does not clear its hurdles, there is none.
How carry is calculated
Carry is a share of profit, so it depends on which profit the agreement counts and in which tiers the carry applies.
Carried interest = carry rate × profit distributed in the tiers where the carry applies
- Carry rate: the GP’s share in that tier, for example 20%.
- Profit: distributions above contributed capital, after the preferred return if there is one.
- Catch-up: with a full catch-up, carry reaches the carry rate × all profit; without one, it applies only to profit above the pref.
The Section 1061 three-year holding period
Section 1061 of the Internal Revenue Code, added by the Tax Cuts and Jobs Act of 2017, applies to an "applicable partnership interest": a partnership interest held in connection with substantial services in a business of raising or returning capital and investing in or developing specified assets. Specified assets include real estate held for rental or investment.
For those interests, long-term capital gain is generally treated as short-term capital gain unless the holding period is more than three years, instead of the usual one year. Short-term gain is taxed at ordinary income rates.
Final regulations issued in 2021 set out how the rule works, including which holding period counts and the exceptions. One exception covers returns on capital the GP actually invested. The regulations also exclude some gains, including Section 1231 gain, which can arise on real property used in a business, such as rental property held for more than a year. Whether a given sale is affected is a question for your CPA.
Congress has proposed changes to how carried interest is taxed several times. Check the current rules with your CPA before you rely on any of this.
Example: the same promote, three holding periods
A GP holds a promote interest in a partnership that owns an apartment property held for investment. At sale, $400,000 of long-term capital gain is allocated to the GP’s promote. Section 1061 generally looks at how long the partnership held the property it sold.
Rental property can produce Section 1231 gain, which the regulations exclude, so the real answer depends on how the property was held and how the gain is characterized. The table shows only the holding-period test.
| Partnership held the property | Gain allocated to promote | Holding-period test alone |
|---|---|---|
| 2 years | $400,000 | Generally short-term unless an exception applies |
| Exactly 3 years | $400,000 | Still short-term: the test is more than three years |
| 4 years | $400,000 | Can remain long-term capital gain |
What to watch for
Carried interest touches the agreement, the ledger and the tax return. Check:
- Capital vs carry: returns on cash the GP co-invests are not carried interest. The agreement and the records should keep them apart.
- Fees are not carry. Acquisition and asset-management fees are generally ordinary income to the recipient.
- Exit timing: a sale in year two or three of a hold can fall inside the three-year window.
- Reporting: partnerships provide holders of these interests with Section 1061 information alongside the K-1, which IRS guidance calls the API one-year and three-year distributive share amounts.
- Clawback: promote returned under a clawback raises its own tax questions. Ask your CPA how it is treated.
- Grants: a promote is usually granted as a profits interest. How it is taxed when granted is a separate question for your CPA and counsel.
Primary sources
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.