Monday, September 1, 2014

The $200 million reason Donald Sterling doesn't want to sell the Clippers — capital gains taxes

NBA Commissioner Adam Silver has made it clear that he wants to pressure or even force LA Clippers owner Donald Sterling into selling the team. This would result in hundreds of millions of dollars in profit for Sterling, so as far as punishments go the financial bite here is not large. But Sterling is also 80 years old, meaning that one way or another he's probably not going to be around for very long. And thanks to the magic of tax policy, it actually makes an enormous difference to his heirs whether or not he sells the team.

Consider two different possible scenarios.

In one scenario, Sterling sells the Clippers and then dies, bequeathing $1 billion in cash to his children. In that case, first he pays capital gains tax on his enormously profitable investment in the Clippers. Then when he dies, he pays estate tax.

In the other scenario, Sterling dies and bequeathes the team to his children who then sell it, earning themselves $1 billion in cash. In that case, there would be an estate tax bill and then his kids would be hit with a capital gains tax bill. So it all evens out.

Except it doesn't! That's thanks to §1014 of the Internal Revenue Code ("basis of property acquired from a decedent"), known to tax junkies as the stepped-up basis rule. The way this works is that if you sell an asset you inherited, the basis for calculating your investment profits is the fair market price of the asset at the time you inherited it rather than the price the person you inherited it from originally paid. Which is to say that if you inherit the Clippers and then sell the team right away, you pay no capital gains tax.

Since the top federal capital gains tax rate is 23.8 percent and Sterling's capital gains on the Clippers could easily be $900 million or more this means there's about $200 million dollars at stake in whether he sells the team before or after he dies. That means that if Silver and the NBA do succeed in forcing him to sell the penalty will actually be quite large — the only problem is that it's more a penalty on his heirs than on him.

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