What Donald Sterling’s Ordeal Can Teach Individuals About Estate Planning and the High Cost of Capital Gains Taxes

Many people are familiar with the recent headlines relating to embattled Clippers owner Donald Sterling and the forced sale of the franchise resulting from an audio recording that was released wherein Mr. Sterling purportedly made some very racist remarks.  While it would appear that Mr. Sterling stands to profit greatly from a sale of the Clippers team (even if it is against his will), there are some serious estate planning considerations that his legal and financial advisors must have addressed when determining how aggressively he would contest such sale.

The estate planning considerations I speak of are common to most individuals planning their estate, and it relates to capital gains taxes and the concept of a “step up in basis.”  It has been reported that Mr. Sterling purchased the Clippers for approximately $12 million dollars and, based on a recent bid of former Microsoft CEO Steve Ballmer, the team could now be worth as much as $2 billion dollars (that’s with a B). Therefore, at the current capital gains tax rate,  a substantial tax liability may be incurred upon the sale of the home.  And that does not include any additional California state taxes which may be due.

Alternatively, as Donald Sterling is now eighty years old and reports have surfaced he may be afflicted with cancer, it is somewhat safe to assume that he did not intend on selling the franchise prior to his death, and his children (in all likelihood) would have inherited his ownership stake in the franchise.  If that was the case and they inherited the franchise following his death, his children would likely owe zero ($0.00) capital gains tax if they were to sell the franchise shortly after his death.  That is because if you receive property as beneficiary of an inheritance, your “basis” (which is the original measurement the IRS uses to determine the amount of capital gains tax due upon subsequent sale of the property) is the value as of the date of the death of the owner, not the value in which it was purchase at.  This concept is what is commonly referred to as a “step up in basis.”

Certainly in this case there are other factors to consider relating to the financial implications of a potential sale, including the difficult time he would have continuing to own the team given his tarnished reputation (to say the least), and the likelihood that Mr, Ballmer’s offer exceeded all reasonable valuations of the team’s worth.  Additionally, although he may save on capital gains taxes by not selling, the team’s value would still be a part of his estate subject to estate taxes.

It’s not every day we can tell our clients their concerns mirror that of a multi-billionaire, but Donald Sterling’s concern relating to the preservation of a step up in basis is a common concern of individuals and families in our office.  Most often the preservation of the step up in basis for an individual’s children is important to our clients because the clients have purchased their home for sometimes hundreds of thousands of dollars less than what it is worth today.  Therefore, absent an exception to the capital gains tax rules allowing for a step up in basis, a substantial tax liability would be incurred upon the sale of the home.  However, if planned appropriately, an estate plan can be structured to ensure the children receive the highly coveted step up in basis and are not subject to excessive taxation.

Preserving the step up in basis can be a tricky process and people should be aware that if a home is transferred to their children for no value during the owner’s lifetime, then there will likely be no step up in basis and the children may have to pay capital gains taxes in the event of the sale of the home.