PE Fund Waterfall Calculator

Model how a private equity fund distributes exit proceeds between LPs and the GP — through return of capital, preferred return, GP catch-up, and the carried interest split — with an after-tax breakdown of GP carry under IRC § 1061.

How a PE fund waterfall works

Step 1 — Return of capital

LPs receive back 100% of their contributed capital before any profits are distributed. No carried interest is paid until LPs recover their full investment. This is why carry is a "profits interest" — it is earned only on profits above invested capital, not on capital recovery itself.

The GP also returns its GP commitment capital at this stage (typically 1–3% of fund size). That capital return is not carry — it is the GP's recovery of its own invested dollars.

Step 2 — Preferred return (hurdle rate)

After capital is returned, LPs receive a compounded preferred return — typically 8% annually — on their invested capital before the GP participates in profits. The preferred return compensates LPs for illiquidity and time value. A $500M fund with 99% LP capital and an 8% hurdle over five years requires approximately $232M in preferred return before carry kicks in.

Some infrastructure and credit-oriented funds use lower hurdles (4–6%); some older venture funds have no hurdle. US buyout funds almost universally use 8%.

Step 3 — GP catch-up

Many fund documents include a catch-up provision. During the catch-up phase, the GP receives 100% of subsequent distributions until its total profit share equals the carry percentage. For a 20% carry fund, the catch-up amount equals carry% ÷ (1 − carry%) × preferred return — roughly 25% of the preferred return paid to LPs.

The catch-up ensures the GP earns exactly carry% of all profits above capital, not just profits above the hurdle. Without a catch-up provision, the GP earns carry% only on the remaining profits after the LP has been made whole on preferred return — economically different and less favorable to the GP.

Step 4 — Remaining profits split

After the catch-up, remaining profits split at the carry percentage: typically 20% to the GP as carried interest and 80% to LPs. Some funds use tiered carry — 20% to 2× MOIC, 25% above 2× — but this calculator models a single flat carry rate.

European vs. American waterfall

This calculator models a European (whole-fund) waterfall — LPs must receive return of all capital and preferred return across all investments before any carry is paid. Standard for most European funds and increasingly common for US buyout funds.

An American (deal-by-deal) waterfall pays carry after each portfolio company exit without waiting for full fund capital to be returned. This benefits GPs (earlier carry cash flow) but creates clawback risk: if later deals underperform, the GP owes carry back to LPs. GP partners in deal-by-deal funds should model clawback liability separately from paper carry and maintain escrow reserves accordingly.

IRC § 1061 and the 3-year holding rule

Under § 1061 (TCJA 2017), carried interest gains are treated as short-term capital gain — taxed at ordinary rates (37% + 3.8% NIIT = 40.8% combined federal) — if the underlying fund assets were held for three years or less.¹ Assets held more than three years qualify for long-term capital gains rates (20% + 3.8% NIIT = 23.8% federal, 2026).²

For a typical 5-year PE fund, most carry will qualify for LTCG. The exception: portfolio companies sold within 3 years of acquisition. In a deal-by-deal carry calculation, each exit is tested against the holding period for that specific asset. A company sold 2.5 years after acquisition generates short-term carry, even if the fund itself has been running for 6 years.

The § 1061 clock starts when the GP "acquires" the applicable partnership interest through the disposition — not from fund formation. Issuing the profits interest before fund assets are purchased is a planning lever that some advisors use to start the 3-year period earlier. Discuss specifics with a PE-specialist tax advisor.

What this calculator doesn't model

• Clawback provisions. If later deals underperform, the GP may owe carry back to LPs — especially in American waterfall funds. Model clawback exposure separately.
• Tiered carry structures. Some funds pay 20% carry up to 2× MOIC, 25% above 2×. Only flat carry is modeled here.
• Management fee offset. Many LPAs require a percentage of management fees to reduce the carry basis, reducing effective carry in practice.
• Capital calls over time. This models a single lump-sum investment. Real capital is called over 3–7 years; the preferred return accrues on each tranche from its call date.
• State sourcing rules. CA and NY have specific rules for sourcing carry income that can apply even after you move — see the state tax residency guide. This calculator applies a flat state rate as an approximation.
• § 1061 look-through elections and API re-characterization. Some carry gains may be eligible for specific elections or exclusions. Requires specialist modeling.