Introduction Carried interest is one of the most politically contested and technically complex areas of US-UK cross-border taxation. A US citizen who is a fund manager or general partner based in the United Kingdom receives a carried interest that is subject to UK tax rules on the one hand and US federal tax rules — […]
Carried interest is one of the most politically contested and technically complex areas of US-UK cross-border taxation. A US citizen who is a fund manager or general partner based in the United Kingdom receives a carried interest that is subject to UK tax rules on the one hand and US federal tax rules — including the Section 1061 three-year holding period requirement — on the other.
Specialist US and UK Tax Advisors who understand both the UK’s capital gains treatment of carried interest and the US’s Section 1061 recharacterization rules are the only advisers who can correctly plan and report a carried interest position for a dual-resident fund manager. Getting it wrong — by failing to track the holding period for Section 1061 purposes or by misapplying the UK carried interest rules — can result in a significantly higher combined tax rate than the fund manager expected.
This guide covers the complete US-UK treatment of carried interest for fund managers in 2026. Visit our advisory service:
https://www.jungletax.co.uk/services/us-uk-tax/
US and UK Tax Advisors who specialise in private equity carried interest understand the UK’s treatment of fund managers’ carried interest — where qualifying carried interest is subject to CGT at 28 per cent rather than income tax at 45 per cent — and the US’s Section 1061 rules, which recharacterise short-term carried interest gains as ordinary income where the underlying assets were not held for more than three years. These are overlapping, but distinct frameworks — and managing them simultaneously requires advisers with deep knowledge of both.
The IRS guidance on Section 1061 and carried interest is published at:
https://www.irs.gov/businesses/partnerships/section-1061-regulations
A US citizen who is a fund manager based in the UK receives carried interest from a UK-managed fund. The UK treats qualifying carried interest as a capital gain — subject to CGT at 28 percent. The United States treats the same carried interest as income or capital gain, depending on the Section 1061 holding period test. The treaty interaction between the UK CGT on the carried interest and the US federal tax on the same receipt requires an adviser who can model both simultaneously.
Section 1061 of the Internal Revenue Code requires that carried interest gains from assets held for three years or less are recharacterized as short-term capital gains — taxed at ordinary income rates in the United States. This applies even where the underlying fund assets would otherwise qualify for long-term capital gains treatment. A fund manager whose fund disposes of assets held for less than three years faces ordinary income treatment on the carried interest gain in the United States — regardless of how the same gain is treated in the United Kingdom.
The UK government has made changes to the taxation of carried interest in recent years. The rate applicable to qualifying carried interest — historically 28 percent CGT — has been the subject of legislative pressure and reform proposals. For 2026, US and UK Tax Advisors confirm the current UK rate and the qualifying conditions before advising on the combined effective rate for any specific carry receipt.
Our guide to HNW clients with US and UK assets is at:
https://www.jungletax.co.uk/jungle-tax-news-updates/accountants-for-us-and-uk-hnw-families/
Depending on the type of underlying income, UK CGT paid on qualified carried interest is creditable as a foreign tax for US FTC purposes in either the passive or general basket. Where the UK CGT rate on the carried interest exceeds the US federal rate on the same gain, excess FTC may arise. The US and UK Tax Advisors at Jungle Tax model the FTC position for each carry receipt — confirming the basket, the creditable amount, and the residual US liability after credit.
CGT, not income tax, applies to UK carried interest that satisfies the eligibility requirements. The qualifying conditions require that the carried interest is economically equivalent to a return on a co-investment in the fund. Where the conditions are met, the carried interest is taxed as a capital gain — historically at 28 percent for higher-rate taxpayers on residential property gains and at the applicable CGT rate for other gains.
Where the carried interest does not meet the qualifying conditions — for example, where it is not linked to the fund’s performance or is structured as a fee rather than a profit participation — it is taxed as income. The distinction between qualifying and non-qualifying carried interest is fact-intensive and requires analysis of the specific fund structure and the terms of the carried interest arrangement.
Income-based carried interest arises where the fund’s average holding period is less than 36 months. Where the average holding period test is failed, the carried interest is treated as employment income — subject to income tax and national insurance contributions in the United Kingdom. The US and UK Tax Advisors at Jungle Tax track the average holding period for every fund and advise on whether the income-based carried interest rules apply before any carry receipt is processed.
A UK fund manager who receives carried interest must report it on their UK self-assessment return. Where qualifying CGT treatment applies, the gain is reported on the capital gains supplementary pages. Where income-based carried interest applies, it is reported as employment income. The adviser confirms the correct treatment for each carry receipt before the self-assessment is filed.
Section 1061 requires that carried interest gains from assets held for three years or less are recharacterized as short-term capital gains — taxed at ordinary income rates. The three-year holding period is measured at the level of the underlying fund assets, not at the level of the carried interest holder’s investment in the fund. A fund manager who receives carry on the disposition of a portfolio company held for two years and eleven months has a short-term capital gain under Section 1061 — even though the fund manager has held the carried interest for many years.
The Section 1061 regulations provide look-through rules for funds of funds and other complex structures. The adviser applies the correct look-through analysis to each carry receipt — confirming the holding period of the underlying assets and whether Section 1061 recharacterization applies.
Section 1061 applies to partnership interests held by taxpayers who provide investment management services to partnerships. A carried interest held by a fund manager who provides investment advice or management services to the fund is an applicable partnership interest for Section 1061 purposes. The adviser confirms API status for each carried interest position before any carry receipt is reported.
Where the carried interest is taxed as a capital gain in the United Kingdom, the UK CGT paid is creditable as a foreign tax on the US federal return. The character of the FTC — passive or general — depends on the character of the underlying fund income. The adviser models the FTC basket allocation for each carry receipt and applies the credit against the US federal liability.
The adviser reviews the fund’s legal structure and the carried interest terms to confirm whether the qualifying carried interest conditions are met for UK CGT treatment. The adviser also reviews the average holding period of the fund’s assets to confirm whether the income-based carried interest rules apply.
The adviser tracks the holding period of every underlying fund asset — from acquisition to disposition — to determine whether Section 1061 recharacterization applies to any carry receipt. For diversified funds with assets acquired on different dates, this requires maintaining a holding-period schedule for each portfolio company or asset throughout the fund’s life.
For each carry receipt, the adviser calculates the UK CGT liability, the US federal liability under Section 1061 (where applicable) or the long-term capital gains rate (where Section 1061 does not apply), and the FTC from the UK CGT paid. The adviser confirms the residual US federal liability after the FTC and advises the fund manager on the combined effective rate for the specific receipt.
The adviser prepares the UK self-assessment — reporting the carried interest as qualifying CGT or as an income-based carried interest, as appropriate — and the US federal return — reporting the carry as a long-term capital gain or a short-term capital gain under Section 1061. The two returns are prepared simultaneously to ensure consistency. The HMRC guidance on carried interest is at:
https://www.gov.uk/guidance/disguised-investment-management-fees-and-carried-interest
Ryan is a US citizen. He is a partner at a UK private equity firm. He recently carried an interest in a UK-managed fund. The fund has made four portfolio company dispositions in 2025 — three companies held for more than three years and one company held for two years and eight months. Ryan’s total carry receipt from the four dispositions is £1,850,000.
For UK purposes, Ryan’s carried interest qualifies for CGT treatment — the fund’s average holding period, when weighted by the value of each disposition, exceeds 36 months. The UK CGT on £1,850,000 at 28 percent is approximately £518,000. Ryan reports the gain on his UK self-assessment as qualifying carried interest.
For US purposes, three of the four carry receipts are long-term capital gains — the underlying assets were held for more than three years. The fourth carry receipt — from the company held for two years and eight months — is recharacterized as a short-term capital gain under Section 1061, taxed at Ryan’s ordinary income rate of 37 percent. Jungle Tax calculates the Section 1061 recharacterization and separates the long- and short-term components of Ryan’s carry receipt for the US federal return.
The UK CGT of approximately £518,000 (approximately $658,000) generates FTC. The FTC offsets the US federal liability on the long-term carry receipts entirely because the UK CGT rate (28 percent exceeds the US long-term capital gains rate (20 percent). The Section 1061 short-term component — taxed at 37 percent in the US — has a residual US liability after applying the FTC credit to that portion.
Section 1061 applies at the asset level — not the fund level. A fund manager who assumes that the fund’s overall holding period satisfies Section 1061 may be surprised to find that individual portfolio companies with shorter holding periods produce short-term carry gains. The adviser maintains a holding-period schedule for each underlying fund asset from acquisition through disposition.
UK qualifying CGT treatment requires that the fund’s average holding period exceeds 36 months. A fund with a short average holding period — even where individual dispositions are held for more than three years — may trigger income-based carried interest rules. The adviser confirms the average holding period calculation before any carry receipt is reported as qualifying CGT.
The FTC basket allocation for carried interest depends on the character of the underlying fund income. Carry from a fund that generates predominantly passive income falls in the passive basket. Carry from an active business may generate a general basket FTC. The adviser models the basket allocation for each carry receipt — to ensure the FTC is applied in the correct basket and that excess FTC in one basket is not incorrectly applied against liabilities in another.
Where a fund manager receives carry through a US partnership, the Section 1061 holding period information should appear on the partnership’s Schedule K-1. Where the K-1 does not include this information — or where the carry is received through a non-US structure — the adviser calculates the Section 1061 analysis independently. Omitting the Section 1061 analysis entirely results in an understatement of US ordinary income on the federal return.
The IRS guidance on partnership carried interest is at:
https://www.irs.gov/businesses/partnerships/section-1061-regulations
Jungle Tax is a specialist US-UK cross-border tax advisory firm whose US and UK Tax Advisors team includes IRS Enrolled Agents and UK-qualified tax practitioners with specific experience advising fund managers on carried interest planning and reporting across both jurisdictions. We review the fund structure and the carried interest terms — confirming whether the UK qualifying CGT conditions are met and whether the income-based carried interest rules apply. We track the Section 1061 holding period for every underlying fund asset. We model the FTC basket allocation for each carry receipt. We prepare the UK self-assessment and the US federal return simultaneously, ensuring consistency between them. We advise on the combined effective rate before any carry receipt is processed — so the fund manager understands the full tax cost before the distribution is made.
Read our related guide to exit planning and liquidity events:
https://www.jungletax.co.uk/jungle-tax-news-updates/us-uk-cross-border-tax-specialist-exit-planning/
Carried interest planning for a US citizen based in the UK requires specialist US and UK Tax Advisors who understand both the UK’s qualifying CGT treatment and the US’s Section 1061 recharacterization rules — and who can model the FTC interaction between them for each carry receipt.
Three points matter most. First, Section 1061 applies at the asset level — each underlying fund asset’s holding period must be tracked individually. Second, UK qualifying CGT treatment requires the average holding period to exceed 36 months — income-based carried interest rules apply where it does not. Third, the FTC from UK CGT on carry must be modeled in the correct basket to ensure the credit is applied against the US liability.
Jungle Tax | mailto:hello@jungletax.co.uk | 0333-8807974 | https://www.jungletax.co.uk
Section 1061 recharacterizes carried interest gains from assets held three years or less as short-term ordinary income. It applies at the underlying asset level, not the fund manager’s tenure.
Qualifying carried interest is subject to CGT, not income tax. The rate depends on the applicable CGT rate in the year of receipt. Confirm the current rate with a specialist before any carry distribution.
Income-based carried interest applies where the fund’s average holding period is less than 36 months. In that case, the carried interest is treated as employment income and taxed at the UK income tax rate.
Yes. UK CGT on qualifying carried interest is a creditable foreign tax. The FTC basket — passive or general — depends on the character of the underlying fund income. Model this for each carry receipt.
Yes. Section 1061 applies to applicable partnership interests regardless of where the fund is domiciled. A US citizen receiving carry from a UK fund is still subject to Section 1061 on the US return.
The adviser maintains a schedule of every portfolio company acquisition and disposition date throughout the fund’s life. Each disposition’s holding period is calculated, and Section 1061 applies when the period is three years or less.
