Friday Letter Yes, he can (raise tax on carried interest)

Barack Obama’s election was all about change. Private equity real estate GPs will be a part of that, whether they like it or not. 

Barack Obama’s election this week as the 44th President of the United States was historic – not least for the fact that the scale of the challenge facing Obama is considerable.

Obama was elected on a promise of change. So were the many new Democratic House Representatives and Senators who now join an energised majority. This means that certain changes defeated by a Bush White House could sail through.

Among these likely changes proposed by Obama and company – higher tax rates on carried interest and capital gains.

The issue of carry tax – where carried interest has been taxed at the 15 percent capital gains rate rather than at the individual income tax rate, typically 35 percent for high-income individuals – has been a political football for many years.

2009, however, could be the year in which private equity real estate fund managers see the issue resolved once and for all, and not in their favour.

Throughout his campaign, Obama explicitly highlighted carried interest as a possible target for tax rises. Coupled with increased Democratic majorities in both the US Senate and House of Representatives, together with public outcry over Wall Street compensation packages and bonuses, there is little reason not to expect carry to be an early contender for change.

As one New York real estate lawyer said this week: “This administration will be looking for revenue sources and revenue offsets for the things they want to do.”

Critics will of course bemoan the burden the effect tax rises will have on attracting – and retaining – talent in the US. But just like the UK’s introduction of higher taxes for non-domiciled residents, the changes are highly unlikely to prompt an exodus of leading GPs to other shores.

Instead, these fund managers could look to other fee structures – possibly including management fees – in which to maximum their returns. Changes such as these would take time, not least to introduce, but to convince investors of their merit.

In the meantime though, change is likely on the way for private equity real estate. GPs should perhaps console themselves with the thought that this year there’s hardly any carry to go around anyway.