Contracts “Worth Millions”, but have no tax basis or value
By Steven C. Dilley. Contributor to South-Western Federal Taxation Series
Professional sports teams have their players under contract. These player contracts can be traded for other teams’ contracts. These transactions are often referred to by the media as trades of players. They are actually trades of player contracts.
Example: Football Team A has L, a linebacker, under contract for the current and two subsequent seasons. L’s contract covers him for $10 million per annum. L is not performing to expectations so Team A trades L for a fourth-round professional football draft choice. The transaction involves no cash.
Federal tax purposes, Team A hadn’t capitalized any cost of L’s contract. How does Team A calculate the gain or loss resulting from L’s contract being disposed of? How does Team B calculate the basis of L’s contract?
These questions were recently answered by Rev. Proc. 2019-18 (2019-18 IRB 1077) It created a safe harbour that allowed both sides to have no amount realized, and therefore no recognized gain or loss.
What is Safe Harbor?
The safe harbor must meet four conditions:
3.01. Safe harbor must be used by all parties to trade. All parties to the trade who are subject to federal income taxes in the United States should treat the trade as such on their federal income tax returns.
3.02. Only personnel contracts, draft choices, and cash are allowed. Each team involved in the trade must receive and transfer a draft pick or personnel contract. A trade does not allow for the transfer of any other property than cash, draft picks, personnel contracts, or cash.
3.03. No amortizable Section 197 intangibles. No amortizable Section 197 intangibles may be included in the trade.
3.04. Accounting treatment. Accounting treatment.
Analyzing Safe Harbor Requirements
Requirement 3.01 states that both parties must use the safe harbor. Also, it is important to call the tax accountant before you execute the trade. Requirement 3.02 states that there must be no other assets than the contracts and cash involved with the trade. In our example, Team B could not provide L with ownership rights to a home in his new community.
Requirement 3.03 states that no SS197 Intangible can be involved. Because player contracts make up a large portion of the purchase price, code SS197 intangibles can often be created. These contracts are amortized over 15 year and subject to SS1245 capture.
Requirement 3.04 states that financial accounting for trades must be consistent with tax accounting. This is a very strict requirement, as “fair value” accounting would require that a gain or a loss be recognized. A sports team that uses generally accepted accounting principles cannot use the safe harbor.
Five results can be obtained by using the safe harbour (see Section 4.02 in the revenue procedure).
(1) A trade does not result in any gain or loss. Except as stated in paragraph (5) below, a trade by a professional sports team of a personnel contract, draft pick, or draft pick is not allowed for federal income tax purposes. This is because the contract value for each personnel contract and draft pick is zero.
(2) Cash received in a trade, computing the amount realized. A team that receives cash in a trade is subject to SS1001. This includes cash received from another team. This revenue procedure treats the contract value of each draft pick or personnel contract as zero. Therefore, a team that does receive cash in a deal does not have an amount realized.
(3) Cash in a trade, computing basis. Under SS1012, a team that provides cash to another team in a deal has a basis in the draft pick or personnel contract received equal to the cash provided in the trade. This revenue procedure treats the contract value of each draft pick or personnel contract as zero. Therefore, a team who does not provide cash in a trade has a zero basis on the personnel contract or draft choice received in the trade.
(4) Allocating basis in a trade that involves multiple personnel contracts or draft picks. A team that provides cash to another team for two or more draft picks or personnel contracts must allocate its basis to each such personnel contract or draft choice it receives from such team. This is done by dividing the basis by how many draft picks or personnel contracts the team has received.