IRS provides relief to professional sports teams that trade player contracts

Tax Hot Topics newsletterThe IRS issued Rev. Proc. 2019-18, providing a safe harbor that generally allows professional sports teams to treat the value of player contracts and draft picks as zero in determining gain or loss on the trade for federal income tax purposes.

In general, sales, exchanges and other dispositions involving property generate realized gains to the extent that the amount realized is greater than the adjusted basis in the property given up. Those gains are typically recognized in income in the year of disposition, unless otherwise deferred. Prior to the enactment of the Tax Cuts and Jobs Act, which restricted the application of Section 1031 like-kind exchanges to real property only, professional sports teams generally treated trades as like-kind property, and were therefore exempt from recognizing gains in the year of the exchange. Without this safe harbor, teams could no longer apply Section 1031, and would need to value contracts for purposes of determining gain or loss on each trade.

Over the life of a player’s contract, the value may fluctuate based on many factors, including performance, the needs of the team, fan attendance, size of the team’s market, injuries and the expectations of the player’s team. Generally, each team that makes a trade of player contract or draft pick believes that it is receiving something of equal or greater value than what it gave up. However, the determination of whether a player is paid above or below market may be different for each team involved in the trade, because of the difficulties in valuing a player’s contract. As a result, assigning a monetary value to the player contract would likely be different for each team involved in a trade, which makes the determination of an amount realized in the exchange difficult.

The IRS provided the safe harbor to avoid highly subjective, complex, lengthy and expensive disputes upon exam. In order to qualify: (1) all parties to the exchange must use the safe harbor; (2) the exchange may only include player contracts, draft picks and cash; (3) no personnel contract or draft pick may be a Section 197 intangible; and (4) the financial statements of the teams must not reflect assets or liabilities from the trades, other than cash.

If the exchange qualifies for the safe harbor method, there is generally no gain or loss on the trade, except if cash is involved. If a team receives cash, that amount becomes an amount realized and, to the extent there is no basis in the player contract given up, the cash will be an amount recognized as a gain. If a team pays cash as part of the trade, then it will have recoverable basis in the player contracts received. The team allocates the basis by dividing the cash paid by the number of player contracts and draft picks received equally, without regard to a valuation of the contracts received.

For example, Team A trades Player Contract 1 and $10 to Team B for Player Contract 2. Assume neither team has basis in the Player Contracts and all the requirements to use the safe harbor method are met. In this instance, Team A has no gain or loss on the exchange, but does have $10 of basis in Player Contract 2 that it received, which it will recover over the remaining life of the contract. Team B has a gain of $10 on the exchange, because it received cash, and has no basis in Player Contract 1 that it received.

The safe harbor method is effective for trades entered into after April 10, 2019. However, teams may choose to retroactively apply the safe harbor in any open year. Each trade needs to be separately analyzed, and the safe harbor is applied by following the revenue procedure.

Sharon Kay
Partner, Washington National Tax Office
T +1 202 861 4140

John Suttora
Managing Director, Washington National Tax Office
T +1 202 521 1523

Caleb Cordonnier
Tax - Manager, Washington National Tax Office
T +1 202 521 1555

Debbie Shi
Tax - Manager, Washington National Tax Office
T +1 202 521 1501

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