May 8, 2014

Stepped up basis another reason Sterling may fight Clippers sale

Update: 5-9-14: It has been reported that the Clippers are owned by a trust in the names of Donald Sterling and wife Shelly Sterling, with the couple's two children as beneficiaries. Mrs. Sterling announced today that she intends to hold onto her 50% ownership. Legal analyst Jeffrey Toobin contends that she does not have a 50% interest; that in effect the same entity, the trust, owns the team. Complicating the matter further is the fact that California is a community property state, and that effectively means each spouse owns 100% of the asset. In the meantime, the NBA has said it will not permit Mrs. Sterling to retain ownership.

The Donald Sterling - L.A. Clippers story doesn't lack for intrigue. There's even an estate planning angle - one so important that it could well influence the outcome of the entire story. It also demonstrates a good rule of thumb for anyone who wishes to leave heirs highly appreciated assets.

The owner of the LA Clippers basketball team, Sterling has been banned for life from the game and fined $2.5 million (a drop in the bucket for a man Forbes estimates to be worth $1.9 billion). The NBA is also trying to force him to sell the team. Sterling acquired the Clippers in 1981 for $12.5 million. By some estimates, the team may now be worth as much as $1 billion.

Here's the estate planning angle: Sterling is 80. He reportedly has cancer. He has two sons and a daughter. If he sells the team ( or his interest in it, because he supposedly co-owns it with his wife) prior to his death, he will have to foot a capital gains bill based on the difference between the current sales price, and what he paid for it in 1981. That amounts to hundreds of millions of dollars in federal capital gains tax and California capital gains tax. 

But, if he can fight the sale and bequeath the team to his children - who are presumably his heirs - they will inherit it on a stepped up basis. That means that it is the fair market value at the time Sterling dies, not the value at the time he bought the team, that will be used to calculate the investment profits when his kids sell the Clippers. Here is the relevant excerpt of Section 1014(a) of the Internal Revenue Service Code:

"...the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be (1) the fair market value of the property at the date of the decedent’s death...

Obviously, hanging onto the team and passing it to his children after his death will save Sterling's kids millions. This is one of the reasons Sterling is likely to resist the call for him to sell now.

Not a billionaire yourself? No matter: the same principle applies to your estate planning, too. Generally speaking, it's wise to refrain from giving your beneficiaries highly appreciated assets while you are alive. If your loved ones inherit the asset at your passing, they will get the advantage of a step-up in basis and the associated tax savings when they go to sell it.

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