Carried interest — “carry,” or in real estate the “promote” — is the general partner’s share of a fund’s profits, typically 20%, earned only after investors receive defined returns first. It is the performance side of private fund compensation, designed to align manager pay with investor outcomes.
How carry works
Carry lives inside the waterfall, the ordered rules for splitting distributions. The standard sequence: limited partners receive their capital back; they then receive the preferred return (commonly 6–8% annually) on that capital; a GP catch-up tier then routes distributions predominantly to the GP until it holds its agreed share of profits; and thereafter every dollar splits — typically 80% to LPs, 20% to the GP. Together with the management fee, this is the two-and-twenty architecture, though headline terms vary: premium managers charge more, first-time funds less, and tiered carry (higher percentages above return thresholds) is increasingly common.
Two design choices determine how investor-friendly a given carry actually is. Timing: a European waterfall pays carry only after all fund capital is returned; an American (deal-by-deal) waterfall pays carry on each realized winner along the way, exposing LPs to overpayment if later deals sour — the clawback provision exists to recover exactly that excess, with all the practical difficulty of recovering paid compensation years later. The hurdle and catch-up mechanics: whether the preference compounds, whether the catch-up is 100% or shared, and what expenses reduce distributable proceeds all shift real economics in ways the “20%” headline doesn’t reveal. The PPM's waterfall section, not its summary, is where these live.
Tax treatment — and the perennial debate
Because carry is structured as a profits interest in the partnership, the GP’s share of gains keeps the character of the underlying income: long-term capital gains in the fund arrive as long-term capital gains to the carry holder, taxed at preferential rates rather than as compensation. Since the 2017 tax law, Section 1061 requires a three-year holding period for carry to receive long-term treatment — a constraint that bites in quick-flip situations but rarely in buyout or real estate holds. The treatment remains one of tax policy’s most durable controversies, surviving repeated reform proposals across administrations; advisors should treat the current rules as settled law with headline risk, and note that carry taxation is the GP's issue — LP taxation follows the LP’s own allocations regardless.
For clients evaluating funds, carry’s diligence value is alignment analysis: how much of the GP’s own money is invested alongside (the GP commitment), whether carry vests across the team that generates returns, and whether the waterfall pays for genuine outperformance or merely for time. A fund’s fee-and-carry load is the price of access; whether the structure earns it is the underwriting question.
FAQ
What is carried interest in simple terms?
The fund manager’s cut of the profits — usually 20% — paid after investors get their money back plus a minimum return. It’s how managers get rich when investors do.
Why is carried interest taxed as capital gains?
Because it’s structured as a share of the partnership’s investment profits rather than a salary, it inherits the character of the fund’s gains — long-term capital gains if the underlying assets were held over the required period (three years for carry under current law).
What's the difference between carry and the promote?
Terminology by asset class: “promote” is real estate’s word for the sponsor’s performance share; the mechanics — waterfall tiers, preferred return, splits — are the same family.
What is a clawback?
A provision requiring the GP to return carry received early (typically under deal-by-deal waterfalls) if the fund’s final results don’t justify it — protection that’s better on paper than in collection, which is why waterfall structure matters upfront.
Related terms
Waterfall · Preferred Return · GP Catch-Up · Clawback · Two and Twenty · European vs. American Waterfall
Educational content only; not investment, tax, or legal advice. Consult qualified professionals regarding your specific circumstances.
