Key Takeaways
- • RSM US tax analysis warns that continuation vehicle (CV) rollovers are "tax-deferred," not "tax-free," because the exchange of historic fund interests for CV interests can drive a future taxable gain without a corresponding cash distribution.
- • Per PitchBook data cited by RSM, private credit CV volume is estimated to have tripled from 2023 to 2025, and venture capital CV market size is projected to grow by $1.5 billion over the next two years.
- • The prevalence of CVs as a fraction of all private equity exits leaped dramatically in the first half of 2025 compared with recent years, as sponsors seek liquidity amid tight private deal and IPO markets.
- • Rolled unrealized carried interest is treated as an applicable partnership interest under Section 1061, so long-term gains with holding periods under three years used to fill the 704(c) layer may be taxed at short-term rates.
- • Transfers into a CV can render assets ineligible for QSBS treatment, and the original issuance test may disqualify certain CV investors from the gain exclusion.
Summary
Private equity sponsors are turning to continuation vehicles (CVs) to increase distributions to paid-in capital amid headwinds in the private deal and initial public offering markets, according to RSM US. CVs facilitate the sale of partnership interests in existing funds rather than the underlying assets, returning value to limited partners (LPs) and potentially unlocking liquidity to support fundraising. RSM notes that the prevalence of CVs as a fraction of all private equity exits leaped dramatically in the first half of 2025 compared with recent years. Citing PitchBook data, RSM estimates private credit CV volume tripled from 2023 to 2025, and projects the market size of venture capital CVs to grow by $1.5 billion over the next two years.
RSM emphasizes that CV rollovers are tax-deferred rather than tax-free. Rollover partners' pro rata interests are set by the fair market value of their roll, which crystallizes unrealized gain. Because the CV's fair market value generally exceeds the tax basis of contributed assets, the taxable gain is nontaxable at transaction under section 721(a) but will be captured later. Tracking this built-in gain requires maintaining a 704(c) layer for each partner and, in multi-asset CVs, tracking it separately for each asset as assets are sold. RSM warns that this can create a cash-to-tax disparity, which is greater when the historic general partner rolls a significant amount of unrealized carried interest.
RSM also flags that rolled crystallized carried interest is treated as an applicable partnership interest under section 1061 of the 2017 Tax Cuts and Jobs Act. As a result, long-term gains with holding periods under three years used to fill the 704(c) layer could be subject to short-term capital gains rates at the individual level, a risk relevant to add-on acquisitions. On qualified small business stock (QSBS), RSM notes that the One Big Beautiful Bill Act, passed in July 2025, expanded the gain exclusion, introduced additional tiers and broadened eligibility to larger companies. Asset transfers into a CV frequently render assets ineligible for QSBS treatment, and the original issuance test may disqualify certain CV investors.
RSM also outlines additional structuring considerations. CV waterfalls often depart from the classic 20% carried interest structure and are frequently tiered by fund performance, aligning LPs holding assets for extended periods and incentivizing sponsors to maximize value in a shorter timeframe. Section 754 elections and resulting 743(b) basis adjustments can equalize inside and outside basis for new investors and smooth realized gains or losses. Sellers of operating U.S. partnerships may also face effectively connected income (ECI) realization, with potential withholding tax when foreign investors are involved. RSM recommends working with tax and legal advisors to avoid surprises and optimize CV transactions.
RSM emphasizes that CV rollovers are tax-deferred rather than tax-free. Rollover partners' pro rata interests are set by the fair market value of their roll, which crystallizes unrealized gain. Because the CV's fair market value generally exceeds the tax basis of contributed assets, the taxable gain is nontaxable at transaction under section 721(a) but will be captured later. Tracking this built-in gain requires maintaining a 704(c) layer for each partner and, in multi-asset CVs, tracking it separately for each asset as assets are sold. RSM warns that this can create a cash-to-tax disparity, which is greater when the historic general partner rolls a significant amount of unrealized carried interest.
RSM also flags that rolled crystallized carried interest is treated as an applicable partnership interest under section 1061 of the 2017 Tax Cuts and Jobs Act. As a result, long-term gains with holding periods under three years used to fill the 704(c) layer could be subject to short-term capital gains rates at the individual level, a risk relevant to add-on acquisitions. On qualified small business stock (QSBS), RSM notes that the One Big Beautiful Bill Act, passed in July 2025, expanded the gain exclusion, introduced additional tiers and broadened eligibility to larger companies. Asset transfers into a CV frequently render assets ineligible for QSBS treatment, and the original issuance test may disqualify certain CV investors.
RSM also outlines additional structuring considerations. CV waterfalls often depart from the classic 20% carried interest structure and are frequently tiered by fund performance, aligning LPs holding assets for extended periods and incentivizing sponsors to maximize value in a shorter timeframe. Section 754 elections and resulting 743(b) basis adjustments can equalize inside and outside basis for new investors and smooth realized gains or losses. Sellers of operating U.S. partnerships may also face effectively connected income (ECI) realization, with potential withholding tax when foreign investors are involved. RSM recommends working with tax and legal advisors to avoid surprises and optimize CV transactions.
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