A new IRS safe harbor lets professional sports teams make tax-free trades of player contracts. Rev. Proc. 2019-18 effectively restores some of the rules that applied to player trades before the Tax Cuts and Jobs Act limited 1031 like-kind exchanges to real property.
The safe harbor treats the traded contracts as having zero value. It applies to trades in any open tax year.
What Sports Trades Can Be Tax- Free?
Teams in professional sports leagues may use the safe harbor for trading:
- personnel contracts; and
- draft picks.
Personnel contracts include employment contracts for:
- coaches; and
- other staff members.
Rules of the Safe Harbor
While IRS lets teams trade sports contracts, the safe harbor includes conditions. A trade will not be tax-free unless these conditions are met.
- All parties to the trade must use the safe harbor.
- Each team must transfer and receive a personnel contract or draft pick, and the only other property they can transfer is cash.
- The personnel contracts and draft picks cannot be amortizable section 197 intangibles. So, for instance, the contracts cannot be goodwill, going concern value, workforce in place, certain covenants not to compete, or similar contracts.
- Cash is the only asset or liability from the trade that the teams can reflect on their financial statements.
Trades Excluded from the Safe Harbor
The safe harbor does not apply to:
- trades that do not satisfy the conditions listed above,
- trades of one team for another team, or
- the sale of a team.
How Does the Safe Harbor Work?
The safe harbor treats a traded personnel contract or draft pick as having zero value. Thus, if a qualified trade does not involve cash:
- neither team realizes gain or loss from the trade; and
- each team has zero basis in the contracts and draft picks it receives.
Player Trades Can Produce Loss
However, a team may have a loss if it has unrecovered basis in a surrendered contract. A team has basis in a contract until it has depreciated its cost, including the athlete’s signing bonus.
Imagine, for example, that the Hohum pro sports team trades away a player in the third year of his five-year contract. Hohum had paid him a $25,000 signing bonus, so it claimed a $5,000 depreciation deduction in each of the first two years of the contract. Thus, at the time of the trade, Hohum still has $15,000 unrecovered basis in the contract. Unless Hohum receives at least $15,000 in cash, it will have a loss on the trade.
What Happens When a Trade Includes Cash?
Although a contract-for-contract trade is tax-free, a team may realize gain or loss if it receives cash in a trade. A team that receives cash has:
- gain if the cash is more than the team’s unrecovered basis in its surrendered contracts and draft picks; or
- loss if the cash is less than the team’s unrecovered basis in its surrendered contacts and draft picks.
Paying Cash Gives Team Basis
A team that pays cash in a trade has an equal amount of basis in the contracts it acquires. If the team receives more than one contract or draft pick, this basis is divided evenly among them. For instance, if a team pays $20,000 in a trade in which it acquires two contracts and three draft picks, it has a $4,000 basis in each contract and draft pick.
Why Did the IRS Provide the Safe Harbor?
The safe harbor is intended to avoid highly subjective, complex, and expensive disputes between pro sports teams and the IRS regarding a team’s gain or loss on a trade.
Of course, a team generally does not agree to a trade unless it believes it will receive something of at least equal value. But it can be very difficult to assign an objective monetary value to a contract or draft pick.
The value of any pro sports contract may change over time based on many factors, such as the player’s performance and fan support. The value that a team places on the contract may also be influenced by the team’s specific needs, rather than the market’s perception of whether the contract represents a good, bad or fair deal for the player’s future services.
Pro Athlete Trades Before 2018
Like-kind exchanges before 2018 could include several types of personal property, including some intangible properties. Under these rules, the IRS had held that player contracts owned by major league baseball clubs were like-kind properties, as were player contracts owned by professional football teams.
Although the new safe harbor does not make pro athlete contracts like-kind property, it does apply rules that are similar to 1031 exchanges.
By Kelley Wolf, JD, LLM