Tax considerations when forming private equity or private credit funds

Alternative investment strategies are increasingly accessible to high-net-worth and mass affluent retail investors through Alts Funds.

Alternative investment strategies — private equity, private credit, hedge funds, real estate, infrastructure, natural resources and digital assets (generally referred to in the industry as “alts”) — have traditionally been offered to ultra-high-net-worth individuals and institutional investors due to high investment minimums and investor suitability requirements. Today, many traditional and alternative asset managers are seeking to make alts investment strategies more accessible to high-net-worth and mass affluent retail investors who are increasingly requesting exposure to these offerings.

To reach this retail audience, alts investment strategies are being offered through pooled investment vehicles registered under the Investment Company Act of 1940, as amended (the 1940 Act). These structures include registered, closed-end interval and tender offer funds, as well as business development companies (BDCs) (collectively referred to herein as “Alts Funds”). In these 1940 Act “wrappers,” investment minimums are generally lower and offer more investor liquidity, less complexity and lower cost than traditional private funds.

As vehicles registered under the 1940 Act, they also offer increased transparency and regulatory and board oversight relative to traditional private funds. These vehicles are generally also structured as regulated investment companies (RICs) for US federal income tax purposes.

We have observed an industry trend of alts and traditional asset managers launching these 1940 Act funds in both the private credit and private equity space. Alternative asset managers, however, may be unfamiliar with the different tax requirements of these products relative to their private funds. While traditional asset managers generally may be familiar with the tax requirements applicable to registered funds, there are additional and unique tax considerations and challenges for these Alts Funds relative to more traditional mutual funds and exchange-traded funds (ETFs). This article provides an overview of US federal income tax considerations for asset managers looking to form these Alts Funds, focusing on private credit and private equity Alts Funds.