Silver Lining

05.05.14

Donald Sterling’s Last Laugh: Force Him to Sell the Clippers and He Could Pay No Taxes

Ironically, the NBA’s ultimate penalty will save the owner as much as $323 million.

Donald Sterling’s reputation had a bad week, but his pocketbook has never looked better. The punishment meted out by NBA Commissioner Silver—the maximum league fine of $2.5 million—pales in comparison to the billion dollars Sterling stands to make from selling the Clippers. Ironically, the league’s nuclear option—a forced sale—could also end up lining Sterling’s pocketbook with millions in tax savings. Instead of his just deserts, will Sterling end up with a sweet tax treat?

First, there’s never been a better time for Sterling to sell, financially speaking.  The Clippers have historically been regarded as one of the worst teams in all of professional sports. During the first 30 years of Sterling’s ownership (1981-2011), the Clippers won more games than they lost only twice. They made the playoffs just four times and managed to eke out only one playoff series win. But since 2011, they’ve made the playoffs every year and are even considered a fringe contender for the NBA title this season. Potential buyers can expect to see strong continued performance because the Clippers’ core is locked up through next year or beyond thanks to Chris Paul, Blake Griffin, DeAndre Jordan, and Coach Doc Rivers.

With this strong platform, the Clippers could sell for $1 billion. Just consider two other NBA teams—worse performers in much smaller markets—that sold in the past year: the Sacramento Kings ($534 million) and Milwaukee Bucks ($550 million). So Sterling, who paid only $12.5 million for the team back in the 1980s, may be able to lock in a 100-fold return on his investment.

If Sterling had voluntarily sold the team for $1 billion, he would have owed about $200 million in federal income tax and another $123 million in California state income tax. But thanks to a tax law that applies only to forced sales or other “involuntary conversions,” Sterling’s profits may all be tax-free.

Section 1033 of the tax code provides a special tax treatment for people whose property has been stolen, appropriated by the government (e.g. eminent domain), or otherwise “involuntarily converted.” The basic idea is that if you have received money because someone took your stuff away from you, you shouldn’t have to pay taxes since you didn’t enter into the transaction voluntarily.

So Sterling, who paid only $12.5 million for the team back in the 1980s, may be able to lock in a 100-fold return on his investment.

(By writing about this tax-saving opportunity, I may inadvertently help Sterling find a silver lining in his well-deserved cloud. Billionaires like him have top-notch advisers who have undoubtedly already identified this tax provision, but I’d take a referral fee for the idea if his guys haven’t. One percent of the $323 million saved should do the trick.)

There are several requirements that Sterling would have to satisfy in order to qualify for this tax benefit. One requirement that is likely to generate controversy with the Internal Revenue Service is that Sterling must use the sale proceeds to purchase “other property similar or related in service or use” to the converted property. The easiest way to satisfy the similarity requirement would be to purchase one or more other sports franchises. However, Sterling may find it difficult—to put it mildly—to find a willing seller, given his unpopularity.

Instead, Sterling could purchase other types of assets and argue that they are “similar or related in service or use” to him. Since the statute doesn’t actually define ”similar” or “related,” Sterling’s lawyers would have ample room to argue that whatever investment property Sterling buys satisfies these vague criteria.

So Sterling could go on a shopping spree with the sales proceeds, substantially diversify his investments, and still benefit from the deferral of hundreds of millions of dollars of taxes. Given his age, this deferral is likely to be permanent. The basis of the replacement property would be stepped up to fair market value at his death, and his Clippers gains would never be subject to income tax by either Sterling or his heirs.

If Sterling claimed benefits under Section 1033, the IRS would undoubtedly audit him. There’s no guarantee that he would ultimately prevail, but with hundreds of millions of dollars at stake, Sterling (a lawyer who is reputed to be both litigious and stingy) would probably fight the case tooth-and-nail.

The events of the past week have likely increased the value of Sterling’s investment by tens of millions of dollars. On top of that, he may be able to save hundreds of millions in taxes if the NBA’s punishment of a “forced” sale is realized. While Sterling’s reputation has been permanently tarnished, his financial future has never looked brighter.