A Sterling Conversion

IMGCAP(1)]You probably know more about Donald Sterling and his mistresses, his infamous recording, and the proposed forced sale of his team, the Los Angeles Clippers, than you want to know. Nevertheless, as tax professionals we should be aware of the tax opportunities and issues for the Sterlings as sellers, if only to make conversation at the next tax-themed gathering we attend.

“The sale of the Clippers will likely present significant estate and income tax planning opportunities at the federal, state and local levels,” said Bradley Marsh, Chair of the Executive Committee of the Taxation Section of the California State Bar Association. “And in a transaction this highly publicized, taxing officials may be interested in challenging them as well.”

“For example, federal and California state law both allow taxpayers who have their property involuntarily converted to invest in replacement investments without paying any tax. Only time will tell how aggressively structured the transaction will be, but for a tax nerd like me, this will be interesting,” added Marsh, a shareholder in Greenberg Traurig.

He cited Section 1033 of the Tax Code, the involuntary conversion counterpart of the Section 1031 like-kind exchange provision. “Section 1033 is not as heavily treaded as Section 1031,” he said. “It’s pretty simple: if property, as a result of its destruction in whole or in part, theft, seizure, requisition or condemnation, or threat or imminence thereof, is compulsorily or involuntarily converted, and the proceeds reinvested within two years, any gain can be avoided.”

“We don’t know the terms of the agreement that the Clippers have with the NBA, but it appears that there is a threat of seizure or involuntary conversion, of them taking it away,” said Marsh. “There was no indication that [Sterling] was ever planning on selling it. Then the threat is made. We don’t know if they [the NBA] have the right to take the team, but it seems he could make the argument that Section 1033 applies, so he would have up to two years to buy replacement property. That doesn’t mean he has to buy another team, just something related in service or use. The proceeds could be diversified into multiple investments. He could buy multiple types of sports or entertainment-related investments.”

“Some will say that the involuntary conversion provision does not apply, but at the end of the day, $700 million [in tax savings] makes it a pretty tempting case to try Section 1033 treatment,” Marsh said. “And it would be a tempting case for revenue agents to challenge on both the state and federal levels. California aggressively audits Section 1031 like-kind exchanges, and I’m sure they would aggressively audit a Section 1033 transaction of this magnitude.”

“Theoretically, the reason the NBA would have the power to force a sale is because he committed a bad act, and he voluntarily entered into the provisions granting the authority to the NBA [to sanction him]. We don’t know what’s been going on behind the scenes, but this presents a unique opportunity for his advisers to attempt to find favorable treatment for him.”

If he is able to achieve section 1033 relief, he and his estate may eventually avoid a tremendous amount of tax, March indicated. “His initial purchase price was $12.5 million back in the early 1980s,” he said. “Under Section 1033 when he makes replacement investments, under federal tax law, the property will receive a stepped-up basis to its market value, currently estimated at around $2 billion. So in theory, when he or his wife passes away, the property will receive a stepped-up basis to its market value, and there would be no gain, or no significant gain, on the entire transaction.”

Meanwhile, even though Sterling seemingly agreed to the sale of the team to former Microsoft CEO Steve Ballmer last week, he issued a statement early this week vowing to “fight for the rights of all Americans. We have to fight these despicable monsters [the NBA]. This is the reason I will not sell my team.”

“That’s an interesting development,” commented Marsh. “Of course, statements like those will likely help make the case that the property is being taken involuntarily, if it is in fact taken.”

And the California Assembly has currently pending a bill that, “for taxable years beginning on or after Jan. 1, 2014, would disallow, under both laws [the Personal Income Tax Law and the Corporation Tax Law] a deduction for the amount of any fine or penalty paid or incurred by an owner of all or part of a professional sports franchise where that fine or penalty is assessed or imposed by the professional sports league that includes that franchise.”

Wonder who they have in mind?

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