The current demand for retail exposure to private assets is unprecedented. The investment vehicles used to deliver this democratization of private capital — primarily closed-end funds — are generally funds registered with the Investment Company Act of 1940 (1940 Act) and are taxed as RICs. With growing investor demand for private equity, private credit, direct real estate, venture capital and infrastructure, RICs present an opportunity for delivering these strategies to a broader investor base.
While the RIC tax status offers clear advantages, using it for portfolios of alternative investments introduces significant complexity. Most RICs do not invest in the private markets. Therefore, it is essential to gain a deeper understanding of the key tax rules governing tax qualification and to have actionable steps to avoid unforeseen tax liabilities.
Private asset tax challenges are primarily driven by the type of tax structure of the underlying investment and are almost identical across different funds, closed-end or not. Therefore, this discussion is relevant to most registered funds that hold alternative assets — private or not.
The following analysis will help you gain the basic tax knowledge, tools to navigate complexities and practical examples needed to align private capital strategies with RIC taxation.
Part 1: Advantages of the RIC Tax Status
- Shareholder Reporting: Form 1099 vs. Schedule K-1
- Fund Taxation: RICs Can Avoid Paying Income Tax
- Private to Public: Is Tax-Free Conversion an Option?
- Accessing Private Markets Through Public Vehicles
Part 2: In-Depth Look at Qualifying as a RIC
- Background
- Gross, or Good, Qualifying Income Test
- Asset Diversification Tests
- Distribution Requirement
Part 3: Critical Tax Considerations for Private Asset Investing Through a RIC
- What Is a Security?
- Corporate vs. Pass-Through Investment: The Look-Through Requirement
- Timing and Transparency: Tax Due Diligence Before Purchase
- Tax Planning Tool: Use of Blockers
- Practical Tax Planning Considerations
Part 4: Tax Pitfalls of Private Asset Investing
- Gross Income Test Failure
- Waiting for Bad Income
- Asset Diversification Test Failure
- Loss of RIC Status
- Industry Knowledge and Technology Gap
- Lack of Control in Private Investments
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Thank you to Brett Eichenberger, Stephen Fisher, Jay Laurila, Eric Lemmon, Erin McClafferty, Rob Meiner, Andreana Shengelya and Claire Toraason for contributing to this publication.