Carried Interest

Carried interest, also known as a "carry," is a share of the profits of an investment or investment fund that the fund manager or general partner (GP) receives as compensation, regardless of whether they contributed any initial funds. This form of compensation serves to incentivize the fund manager to perform well and maximize returns for the fund.

In a private equity fund or real estate fund, the GP typically receives a management fee and a carried interest. The management fee is usually a small percentage of the fund's assets (often around 2%), while the carried interest is a larger share of the fund's profits (often around 20%).

However, the carried interest is usually only paid out once the fund has returned the capital contributions to the limited partners (LPs) and often after a preferred return has been paid to the LPs. The specific terms can vary greatly depending on the partnership agreement.

As an example, let's say a real estate fund acquires a building for $1 million. After several years, they sell the building for $2 million. After returning the initial $1 million investment to the LPs, there's $1 million in profit remaining. If the GP has a carried interest of 20%, they would receive $200,000 (20% of the $1 million profit), in addition to any management fees they collected.

It's worth noting that the tax treatment of carried interest can be a topic of debate, with some advocating for it to be taxed as ordinary income and others arguing it should be taxed at the generally lower capital gains rate.