The IRS has provided a safe harbor for professional sports teams to avoid the recognition of gain or loss when trading players and/or draft picks. Under the safe harbor provision, the traded player’s contract or the traded draft pick would have a zero basis.
Value of Professional Sports Contracts
Professional sports teams enter into contracts with their personnel (e.g., managers, coaches, players, etc.). Typical personnel contracts provide an agreed-upon amount of compensation for a certain duration of service. The value of such a contract may fluctuate based on a variety of factors, including:
- player performance;
- the changing needs of the team and of other teams;
- a player’s effect on fan attendance; and
- the number of years until a player becomes a free agent and is able to sign a contract to play for any team in a league.
Other considerations affecting the value of a player contract include:
- the size of the team’s market (i.e., whether a smaller city or a major urban population);
- the cost of player development; and
- the impact of injuries and slumps on player performance.
In most cases, teams do not trade personnel contracts or draft picks unless the team thinks that it is receiving contracts of an equal or greater value. Because each party believes that they are receiving personnel contracts or draft picks of an equal or greater value, it is difficult to assign a monetary value to them. Accordingly, the IRS developed a safe harbor whereby each team is able to treat the traded contracts or draft picks as having a basis of zero, thus avoiding the recognition of gain or loss on the trade.
Safe Harbor Requirements
In order to use the safe harbor, professional sports teams must meet the following requirements:
- all teams involved in the trade must use the safe harbor;
- teams may only trade personnel contracts, draft picks, and/or cash;
- personnel contracts and/or draft picks cannot be Code Sec. 197 intangibles; and
- the financial statements of all teams involved in the trade must not reflect assets or liabilities resulting from the trade other than cash.
Sports teams using the safe harbor will not recognize any gain or loss if they only trade personnel contracts or draft picks. However, teams that receive cash in a trade will recognize the amount of cash received as gain. In addition, the team providing cash to another team in the trade will receive basis in the personnel contract or draft pick equal to the amount of cash that it provided. A team providing cash to another team in a trade for two or more draft picks or personnel contracts must allocate its basis to each personnel contract or draft pick received from the other team by dividing the basis by the number of personnel contracts or draft picks received.
In certain cases, a team may have unrecovered basis in a draft pick or personnel contract under Code Sec. 167(c). In those instances, the team may recognize gain or loss based on the difference between the unrecovered basis and any cash received.
Teams may use the safe harbor for any trades involving personnel contracts or draft picks entered into after April 10, 2019. However, teams may choose to apply these rules in any open tax year.