Co-investment vehicles under the Deferred Interest Final Settlement – Finance and Banking



United States: Co-investment vehicles under the final deferred interest settlement

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As a result of the latest Treasury regulations issued by the IRS under Section 1061,1 fund promoters should consider investing capital through a blended fund with other investors rather than using their own investment vehicle to invest alongside the fund, which could be subject to the three-year holding period requirement under section 1061.

Section 1061 re-qualifies certain long-term net capital gains with a holding period of less than three years as short-term capital gains at ordinary income rates. Section 1061 applies to an “applicable partnership interest” (an “API”) held by or transferred to a taxpayer in connection with the provision of substantial services by the taxpayer in an applicable trade or business. Deferred interest agreements can constitute an API, which would be subject to the three-year holding period.

However, a “capital interest” in a partnership is generally not an API (the “Capital Interest Exception”). For this purpose, a capital interest is an interest that would give the holder a share of the proceeds if the assets of the partnership were sold at fair market value at the time the interest was received and the proceeds were then distributed. in a complete liquidation of the partnership. . As a result, a participation of a fund promoter may be able to structure part of its investment so that it is exempt from Article 1061 (and the three-year holding period) with respect to its capital. invested under the capital interest exception.

In order for the fund promoter to comply with the capital interest exception, the allocations relating to its capital interest must be reasonably consistent and determined in a manner similar to the allocation and distribution rights that apply to the capital invested by investors. unrelated service providers who have made significant capital contributions (defined as 5% or more of the partnership’s total capital account balance at the time the grants are made). The regulations provide for the following non-exclusive factors for the application of this test: (i) the amount and timing of the capital contributed; (ii) the rate of return on the capital contributed; (iii) the modalities, priority, type and level of risk associated with the capital contributed; and (v) rights to distributions in cash or in property during the operations of the company and in the event of liquidation.

As drafted, it would be difficult to ensure that interest in a fund promoter’s co-investment vehicle qualifies for the capital interest exception, as allowances must be compared to those. made to major unrelated service providers. The Treasury and IRS continue to study the application of the principal interest exception to co-investment vehicles.

Provided the partnership agreement and the books and records of the fund clearly demonstrate the requirements listed above, the fund promoter could co-invest in the investment of the underlying portfolio through a combined fund with unrelated service providers. On the other hand, a fund sponsor who co-invests through its own investment vehicle may not be eligible for the capital interest exception and could therefore be subject to the three-year holding period.


1 All references to the “Section” are to the Internal Revenue Code of 1986, as amended, or to Treasury regulations promulgated thereunder.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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