ARBOR WEALTH: Hank Williams, Don Sterling and capital gains pain
“Your cheatin’ heart … will make you weep…” from “Your Cheatin’ Heart” by Hank Williams
Donald Sterling has now reneged on his agreement to sell the Los Angeles Clippers. Perhaps he changed course when he saw his impending tax bill.
I’m not a basketball fan, but when I heard that a professional basketball team was selling for $2 billion, I wondered how much the seller would actually clear after taxes.
Astute advisors consider similar situations daily on behalf of their clients. How much will the client clear if a holding is liquidated? Or, how much will a client take home if he sells his business? After all, it’s not what you gross, it’s what you make after you settle with Uncle Sam that actually matters. Employing investment strategies that neglect a client’s tax considerations can be detrimental to the client’s finances.
I read recently about a client who changed financial advisors. The new advisor perused the client’s portfolio, saw heavy allocations in one particular dividend-paying utility stock, and immediately sold the majority of the security. Turns out the client had held the stock for several decades and had originally purchased it at a rock bottom price. Because the stock had grown significantly in value, the capital gains taxes were exceptionally burdensome.
Back to basketball. Mr. Sterling was reportedly selling the L.A. Clippers to former Microsoft Chief Steve Ballmer for $2 billion. Sterling bought the team in 1981 for $12.5 million dollars, so the franchise has increased in value by $1,987,500,000.
Assuming no additions to his cost basis, Sterling would likely pay a 20 percent capital gains rate on this $1,987,500,000, or just under $400 million. If the team is determined to be a “non-passive” asset, the Sterlings may have avoided the 3.8 percent Medicare surtax on net investment income. Whew. But Sterling isn’t selling the Miami Heat, a team located in a state with no income taxes. The controversial sale is in California, which just raised its maximum state tax rate to 13.3 percent. That’s over $260 million more owed in state taxes. Now we’ve got a tax liability of $660 million. Taxes are simply part of the equation, in business sales and investing. If you’re considering working with a new investment advisor, ask him what kind of tax analysis will be performed on your holdings prior to the commencement of trading in your accounts.
No need to shed tears for Mr. Sterling if the sale indeed goes through. His franchise ownership produced roughly a 16,000 percent return over a period of 33 years on his original investment. That’s an annualized rate of around 17 percent. This rate of return is surpassed, though, by potential new owner Steve Ballmer, whose original investment in Microsoft has earned him more than 55,000 percent over the last 28 years.
Margaret R. McDowell, ChFC, AIF, a syndicated economic columnist, is the founder of Arbor Wealth Management, LLC, (850-608-6121 — www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.