Potential Tax Savings for Minority Owners of a Sports Team

Minority investors, depending on the team in which they choose to invest, may enjoy many of the perks of ownership that include, but are not limited to, luxury box seats, invitations to team events, and access to current and former players. Investing in sports team is viewed by many as prestigious, and for most owners it can fulfill a childhood dream.

There are also disadvantages that investors should be aware of. As a minority owner, investors generally have no input into the decision making process. They may sometimes be allowed to sit on advisory boards, but have no control over decisions made. Additionally, some investors will have to contribute money on an annual basis to help the team meet its financial obligations.

Currently these types of investments are considered safe due to their continued growth and appreciation. According to Forbes, the average value of sports franchises has increased over 250% since 2000. However, while netting millions of dollars in profits, these sports teams often show losses due to non-cash expenses such as depreciation and amortization.

These on-paper losses have the opportunity to provide investors with significant tax reduction opportunities. For many investors these losses can be considered passive activity losses and can be used to offset other passive activity income on their individual income tax returns. Internal Revenue Service (“IRS”) Publication 925 discusses Passive Activity and At-Risk Rules. In this publication passive activities are defined as trade or business activities in which you do not materially participate during the year. If the investor does not have any other passive activity income to offset; passive losses are carried forward and can be utilized once the investment is sold.

If an investor materially participates in a passive activity they are generally entitled to utilize passive activity losses on their individual income tax return. Under Internal Revenue Code (“IRC”) §469(h)(1), a taxpayer materially participates in an activity if they work on a regular, continuous and substantial basis in operations. If a taxpayer does not materially participate, losses are passive, which means they generally are not deductible in the absence of passive income. Material participation is time sensitive. A taxpayer materially participates in an activity only if they meet any one of the seven material participation tests in Treasury Regulation §1.469-5T(a).

A taxpayer is required to identify the amount of his or her participation in a trade or business activity each year. The type and quantity of time documented determines whether an activity should be treated by taxpayers as passive or non-passive. A taxpayer can have a significant financial interest in a business, and yet not materially participate. Material participation is determined on a year to year basis so it is conceivable that a taxpayer could hold a passive interest one year and non-passive (in other words, materially participating) in a subsequent year.

Per Treasury Regulation §1.469-5T(a), a taxpayer must pass one of the tests below to materially participate in a passive activity:

For these sports fans, 500 hours of material participation can be easily achieved by attending games and enjoying themselves. Additionally, reading articles and watching sports may be included when determining hours needed for material participation.

If an investor materially participates, the net income or loss from the investment is considered non-passive and may be used to offset other non-passive income.

It is important to keep in mind that the burden of proof is on the taxpayer to prove material participation in these activities. It is important for investors to keep in mind that, in order to meet the recordkeeping requirements of Treasury Regulation §1.469-5T(f)(4), a taxpayer must establish material participation by reasonable means. Reasonable records may include:

Contemporaneous daily records are not required if the taxpayer’s participation can be reasonably established.

Furthermore, an investors tax benefit could be limited if the IRS classifies an investment loss as a hobby loss. The IRS reminds taxpayers to follow appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby. IRC §183, Activities Not Engaged in for Profit, limits deductions that can be claimed when an activity is not engaged in for profit. IRC §183 is sometimes referred to as the “hobby loss rule.”

Investors should always consider all of the advantages and disadvantages associated with any potential investment.

The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.