Law and Sports Intersect: A Forced Sale of the L.A. Clippers Could Result in Hundreds of Millions of Dollars in Tax That May Have Been Avoided

While it appears that the NBA has a contractual legal right to force Donald Sterling to sell the L.A. Clippers, exercising that right may have significant income tax consequences for Sterling. Sterling purchased the Clippers in 1981 for about $12.7 million. Recent reports place the team's value in the $2 billion range.

The sale of an NBA team is subject to capital gains tax. As Donald Sterling purchased the Clippers more than one year ago, the long-term capital gains tax rate (23.8%, including all surtaxes) would apply. In addition, Sterling would owe California capital gains tax (up to 13.3%) on his gain.

Capital gains income is generally calculated by subtracting the seller’s basis in the asset from the value of the asset at the time of the sale. Sterling’s basis in the asset is generally his purchase price, minus any adjustments for investment or depreciation of the asset through the years. Capital gains tax is not paid each year based on fluctuations in the value of the asset, but is instead deferred until the asset is sold, when the gain is said to be realized. The forced sale of the Clippers would trigger this, requiring Sterling to pay capital gains tax on the income from the sale.

This forced sale also prevents Sterling from taking advantage of a particularly favorable provision of the Internal Revenue Code related to calculation of basis. Section § 1014 provides that if a person dies while in possession of an asset, the asset’s basis can be “stepped up” to the value of the asset at the time of death. This avoids the significant tax liability associated with the increase in value of the asset that had accrued during that person’s lifetime.

Here, assuming Sterling outlives his ownership of the Clippers (not guaranteed, in light of recent news regarding his health), he will be forced to pay capital gains tax on the sales price (approximately as there will be some adjustments to basis), minus his $12.7 million basis in the franchise. If the Clippers sold today for $2 billion, the tax bill would come to over $600 million. If Sterling dies tomorrow, however, the step up in basis enjoyed as a result could save nearly the entire amount.

One last factor comes into play to further complicate the issue: estate tax. Depending on Sterling’s last two decades of estate planning, all or most of the value of the team could be subject to estate tax, which rates vary from year to year. If Sterling were to die as the owner of the team, the step up in basis could avoid capital gains tax, but any savings on that front could be counteracted by estate tax rates. In the end, regardless of whether a sale is forced or not, Sterling’s tax planning will play a large role in the ultimate amount of taxes owed.

Written by Mr. Alexander D. Racketa, associate attorney with Hinman, Howard & Kattell, LLP.  Please contact Mr. Racketa directly at aracketa@hhk.com or (607) 723-5341 with questions.

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