There's been significant debate in recent days about the potential tax consequences of Donald Sterling selling the Los Angeles Clippers. SI.com interviewed Robert Raiola, senior manager in the Sports & Entertainment Group of the accounting firm O'Connor Davies, LLP, for insight on the most likely effects.
If Sterling sells his equity in the Clippers, Raiola contends that Sterling would pay hundreds of millions of dollars in capital gain taxes. Between federal and California tax capital gain rates, Sterling would pay approximately 33 percent on the difference between what he bought the team for and what it is sold it for. Sterling reportedly acquired the Clippers for $12.5 million in 1981, an inflation-adjusted amount of around $31 million. The team's current value is at least $600 million and more likely in the ballpark of $1-1.2 billion. If Sterling's gain on the sale is $1 billion, he would have to pay about $333 million in capital gain taxes.
There is a twist, however. The Internal Revenue Service permits taxpayers to treat gains from "involuntary conversions" of property as nontaxable income. Internal Revenue Code § 1033 raises this power in the context of property destroyed by "theft, seizure or requisition or condemnation" or converted into money. Any gain resulting from the property's "destruction" can sidestep taxes, provided the taxpayer reinvests the gain within two years, such as by buying other property or stocks.
Unfortunately for Sterling, Raiola believes that the IRS would not treat the loss of an NBA team as an involuntary conversion.
"First," Raiola stressed, "the IRS could argue that the sale was pursuant to bylaws and provisions which Sterling agreed to play by, rather rules being forced on Sterling."
Articles 13 and 14 of the NBA's constitution detail an intricate procedure for owners to terminate the interest of another owner in a team. Sterling and other owners agreed to this procedure. Interestingly, the termination of Sterling's interest in the Clippers would not technically constitute a sale of the franchise. Instead, the NBA and the office of commissioner Adam Silver take control of Sterling's interest. This means the league would essentially run the Clippers, much like it ran the New Orleans Hornets after purchasing the team from George Shinn in 2010. The league would then have the choice of selling the Clippers at a price Silver deems "reasonable and appropriate." From this lens, the sale of the Clippers would not be "involuntary": Sterling would have voluntarily given his blessing to a procedure later used to oust him. Sterling (and perhaps the NBA) would be subject to capital gain taxes in this scenario.
Raiola raises a second reason why Sterling might not benefit from involuntary conversion: IRS rulings and case law indicate that the involuntary conversion must be made at the behest of the government or a government agency. For example, in IRS Private Letter Ruling 91180085, the forced sale of a partnership interest did not constitute an involuntary conversion because the taking of the property was not made by the government. IRS Field Service Advice 200049004, which concerns a corporate breakup fee, is also telling. It outlines that the congressional intent of §1033 was designed for loss of property to the government and/or loss by casualty. The NBA is certainly powerful, but it is a private association and not the government.
"Clearly," Raiola argues, "it appears that Sterling's best course of action would be to defer the sale as long as possible to avoid capital gain taxation or until a favorable settlement is reached with the NBA."
Keep in mind that, as Raiola was first to note in an earlier SI.com article, if Sterling dies while owning the team, he would not have paid capital gain taxes on the Clippers. Instead, his heirs would take Sterling's interest in the team and not be subject to capital gain taxes in that transfer. While they may be subject to estate taxes, the heirs would only pay capital gain taxes if they sell Sterling's interest in the team. Crucially, the gain would be the difference between the value of the team when they inherited it (perhaps $1 billion) and the value of it when sold, rather than the much larger difference between the value of the team when Sterling purchased it ($12.5 million) and the value of it when sold. Tax consequences are among many reasons why Sterling is incentivized to fight the NBA in court.
Michael McCann is a Massachusetts attorney and the founding director of the Sports and Entertainment Law Institute at the University of New Hampshire School of Law. He is also the distinguished visiting Hall of Fame Professor of Law at Mississippi College School of Law.