TL;DR: The manager's ~20% share of fund profits. It's taxed as long-term capital gain — but only if the underlying assets were held for more than three years.

Carry is the bottom step of the waterfall. Because the manager holds a profits interest in the partnership, its share keeps the character of the fund's income — so a gain on a portfolio company sale is capital gain to the GP too.

Since 2018, Section 1061 says carry only gets long-term rates if the asset was held for more than three years (rather than the usual one). Sell after two years and the GP's share is short-term gain, taxed like ordinary income. That's why credit and shorter-hold strategies care much more about this rule than buyout funds do.

The three-year rule for carryTimeline from purchase: a sale before three years gives short-term treatment for the carry; after three years it is long-term capital gain.buy3 yearsSell here → carry taxedas short-term (up to 37%)Sell here → carry taxedas long-term (20% + 3.8%)
Same profit, different date, very different tax bill for the GP.

Worked example

A fund sells a company after 2.5 years for a $50m gain; the GP's carry is $10m. Under Section 1061 that $10m is short-term gain — roughly $4.1m of federal tax (37% + 3.8%) instead of about $2.4m at long-term rates (20% + 3.8%). Simplified: assumes the top bracket and that the 3.8% net investment income tax applies.

Where you'll see it: Carry vesting schedules, GP K-1s with Section 1061 worksheets, and hold-period planning before exits.

Code: IRC § 1061 · Related: Distribution waterfall, Schedule K-1 (and K-3)

Full explainer: carried interest →

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This glossary is general information, simplified for learning. It is not tax, legal or investment advice, and real structures turn on facts and documents not shown here.