Smart Sports Franchise Buyers Put Tax at the Center of the Deal

Sports franchises are more valuable than ever, causing professional teams to change ownership and capture these gains for their investors. Eighteen teams in three of America’s major sports leagues have changed ownership in the last decade. Even for taxpayers capable of such a purchase, it’s not necessarily easy to obtain financing and understand the tax implications of how a third-party sale or self-financed sale is structured.

When the pricing and financial performance of a sports franchise are misaligned, external financing may not be advantageous or practical. Various leagues restrict the level of debt-financing a buyer can use to acquire a team and which types of individuals and entities may acquire a team. Even if a buyer must pony up their own cash, reporting an installment purchase may still have large tax benefits while giving the owner time to part with the cash.

Installment Versus Creeping Acquisitions

An installment sale is structured as an agreement to sell a fixed percentage of equity for a fixed price over a period of time. A creeping acquisition is structured as an agreement to acquire different stakes of equity at different milestones. They are mutually exclusive with potentially meaningful tax consequences, most critically who owns how much and when.

Generally, an installment purchase permits a buyer to make a series of payments over an agreed-on period, with a stated or imputed interest component. Under the default rule, sellers recognize the payments pursuant to a mildly complex formula, and the sellers are required to impute interest income such that it would behoove them to require the buyer to pay interest.

In addition, if the seller uses the installment method to report the taxable gain over time, they may owe interest to the IRS for the taxes (which are also deferred) on the gain. Sellers may choose to forgo the installment method when they anticipate significant offsetting deductions or losses for the same tax year or expect to be subject to higher tax brackets in later years. However, many choose to pursue the installment method to align the tax bill with the cash payments.

In a creeping acquisition, each incremental equity purchase bears the risk that either party could back out of the deal or another buyer could come in and make a better offer. The sellers do not have to recognize interest income, as the sellers are not treated as deferring gain since they retain the equity that the buyer has not yet purchased.

The parties determine whether their transaction is viewed as an installment sale or a creeping acquisition by examining the facts and circumstances to determine whether and when the sellers have transferred the economic benefits and burdens of ownership to the buyer, which include:

The risk of loss and enjoyment of the appreciation in value;
The legal title to the equity or the right to dispose of the equity;
The right to vote on governance matters;
The right to pledge the equity as collateral; and
The rights to distributions.

Most negotiations are a game of inches. Terms in sports team acquisitions may deviate from normal financial practice due to the non-financial motivations of the parties, the leagues themselves, or both. Some benefits or burdens of ownership may not be entirely within the sellers’ power to transfer, including the ability to lever or take distributions from the team, which may be limited by the league. These limitations, coupled with restrictions on debt-financing, can drive uniquely negotiated economics.

Each incremental subtraction to the buyer’s economic benefits and burdens of ownership can change the tax ownership of the team’s equity. That highlights the differences between the financial and governance aspects of team ownership versus the tax and liquid cash flow aspects.

Partnership Acquisitions

The IRS is particularly interested in the characterization of an acquisition as an installment sale or a creeping acquisition when the target of the acquisition operates as a partnership.

Many sports teams operate as partnerships for income tax purposes. Partnerships are generally not subject to entity-level taxes, and partners are allocated items of the partnership’s income, deductions, gain, and loss pursuant to the partnership’s operating agreement.

Partnerships also give the teams and their owners the greatest flexibility in tax reporting, such as allowing owners to potentially take an active role in managing the team, which could transform the income and losses to active status for purposes of the passive activity rules. This can permit active owners to avoid the 3.8% net investment income tax imposed on passive income and claim losses without being limited to overall passive income each year.

If properly structured, many partnership equity transactions can generate tax benefits to buyers in the form of stepped-up tax basis of the partnership’s assets as a result of a Section 754 election. Where the step-up in tax basis is allocable to depreciable and amortizable property, the buyer can take additional tax deductions.

Step-up in tax basis the buyer receives is determined by several factors when the Section 754 election is made:

Consideration paid to sellers;
Fair market value of partnership’s assets;
Mix of partnership’s assets as certain assets are allocated purchase price in priority above the others;
Amount of liabilities deemed assumed by buyer; and
Amount of the equity acquired by buyer.

The amount of equity acquired, and the liabilities deemed assumed by the buyer, are both functions of how the acquisition is treated for tax purposes.

Economically, if the buyer is obligated to pay a fixed amount (inclusive or exclusive of interest), and if the acquisition is structured to obtain the step-up in tax basis, the tax deductions should be identical in both.

However, installment buyers may accelerate the deductions into the original year of sale, which could make the installment construct meaningfully valuable to a buyer with sufficient ability to absorb those deductions.

Alternatively, a buyer may anticipate liquidity events from other sources that may make the deferral of tax deductions to later years more attractive. In the end, though, an individual buyer’s ability to use any income tax losses may be limited by their tax profile and other facts and circumstances.

A Winning Strategy

Although neither the negotiation of the price nor the terms may be driven by tax implications, it would be shortsighted to close a deal without considering them, given the meaningful differences between financing options.

A buyer or seller may be able to project whether owning more or less of the team could mitigate the tax burden of other transactions they are planning, or they could prepare a more efficient estate plan. Understanding the tax impact of the terms of their deal is simply adhering to one of sports’ most famous strategies: The best offense is a good defense.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Amanda Hodgson is a senior manager in the mergers and acquisitions tax group at RSM US LLP in Austin, Texas. She advises buyers and sellers in the middle market on tax considerations of acquisitions, dispositions, internal reorganizations, and other transactional events across a variety of industries.

Jamie Sanders is a partner in RSM’s private client services practice in Houston. Her primary expertise includes income tax, estate tax and personal financial tax planning.

Justin Krieger is a director serving RSM Canada’s technology, media and telecommunications clients. He is based out of the firm’s Toronto office.