GOODWIN 31 gains, dividends, and investment interest. For high income taxpayers, trades or businesses eligible for the reduced rate do not include any trade or business where the principal asset of the trade or business is the reputation or skill of one or more of its employees, specifically including consulting, investing, and investment management. High income taxpayers also are limited in the amount of qualified business income they can deduct with respect to any particular trade or business to the greater of (i) 50% of the W-2 wages with respect to that trade or business or (ii) the sum of 25% of such W-2 wages plus 2.5% of the aggregate initial basis (i.e. unreduced for depreciation) of tangible depreciable property used in that trade or business that has not been fully depreciated or that has been placed in service by the taxpayer less than 10 years ago (referred to as “qualified property”). Land basis does not count towards the 2.5% qualified property base, as land is not depreciable. This limitation does not apply to the deduction for REIT dividends or qualified income allocated from publicly traded partnerships. PRACTICAL OBSERVATIONS • W-2 wages and qualified property limitations. Outside of some public UPREIT partnerships and publicly traded partnerships, we expect that many real estate partnerships do not have material W-2 employees, so that their partners’ ability to claim the Pass-Through Deduction will depend largely on the amount of initial basis in qualified property. Contributing REIT-eligible properties to a subsidiary REIT, especially if the property is not qualified property, is an obvious strategy if Pass-Through Deductions are limited by the amount of W-2 wages and qualified property basis. UPREITs and other “internally managed” partnerships should review their payroll arrangements to assess the W-2 wage base available for the Pass-Through Deduction. Structures that separate employees from the real estate assets, such as housing employees in taxable REIT subsidiaries to address certain REIT compliance issues or the use of affiliated management companies or common paymasters, may reduce the available W-2 wages and might have to be revisited. • Uncertainties regarding qualified property. The new rules leave many unanswered questions as to how the 2.5% amount is calculated in the case of property acquired in a tax deferred transaction, such as a like- kind exchange, a contribution to a partnership or S corporation or merger of operating partnerships. • Real estate debt. Qualified property does not include real estate loans. Real estate debt funds and similar other partnerships with individual taxable investors might consider use of a REIT structure in order to benefit from the Pass-Through Deduction in respect of such loan investments. • Conflicting tax objectives. The 20% Pass-Through Deduction creates new conflicts amongst different groups of investors. For example, capitalizing partnerships or private REITs with member loans to mitigate UBTI for tax exempt investors and/or reduce US withholding taxes for non-US investors may now be disadvantageous for non-corporate taxable US investors by converting some income that would be eligible for the Pass-Through Deduction into income that does not qualify. • REIT dividends through mutual funds. Although the statutory language does not extend the 20% rate to REIT dividends earned through mutual funds, Treasury should have the authority to do so by regulation (and hopefully will). CARRIED INTEREST Unlike prior proposals to tax all carried interest at ordinary income rates, the TCJA largely retains the current taxation of carried interest for non-corporate service partners, but extends the long term capital gain holding period from one year to three years. Capital gains allocated to carried interests from capital assets held for three years or less will be treated as short-term capital gain, which is taxed at ordinary income rates and is not eligible for the 20% Pass Through Deduction. In addition, capital gain on the sale or disposition of the carried interest itself also will be treated as short term capital gain to the extent the service partner has not held the interest for more than three years. The new extended holding period applies to all carried interest, including carried interest granted prior to enactment of the TCJA. The new rules apply to carried interest issued by a partnership engaged in an “applicable trade or business,” which generally requires both (i) raising or returning capital and (ii) investing in, disposing of, and/ or developing investment assets such as stocks, debt, interests in widely held or publicly traded partnerships and other securities, real estate held for rental or investment, and interests in partnerships to the extent the partnership holds any of the foregoing investment assets. The TCJA also added special provisions that can require immediate recognition of short-term capital gain upon certain direct or indirect transfers of carried interest to family members and certain co-workers, including otherwise tax deferred transfers such as gifts.