Smith School Tax Expert Weighs in on Baltimore Orioles Sale

In the early stages of spring, baseball season is quickly approaching, which means tax season is, too. And this year, the Baltimore Orioles might be busy with both.

The Orioles, amid finalizing its reported $1.725 billion sale from January, still have plenty to work out with the deal's financial details. Longtime owner Peter Angelos, who acquired the team in 1993 for $173 million, is passing ownership to a group led by Baltimore native and private equity billionaire David Rubenstein.

The transaction is expected to follow a two-step process—Rubenstein, in the short term, will immediately acquire 40% of the team and purchase the remaining 60% following Angelos’ death. Structured this way, the Angelos family could save up to $250 million in capital gains tax—a tax on the profit from an asset’s sale.

According to Samuel Handwerger, CPA and accounting lecturer at the University of Maryland’s Robert H. Smith School of Business, structuring the deal this way appears that the Angelos family is looking to utilize the step-up in basis rule of Section 1014 of the U.S. Tax Code for the remaining 60% sale, “where the unrealized gains go away by virtue of the heirs receiving inherited assets with a tax basis based on the fair market value at the date of death.” This so-called “step-up” allows the heirs to sell those assets without any gain or loss.

Aside from anything that potentially gives Rubenstein complete beneficial ownership now instead of the reported 40%, there’s usually no cause for the IRS to disturb this two-step process, says Handwerger. That means this transaction cannot be otherwise considered an installment sale in the traditional sense, as inherited installment sale notes are not subject to the stepped-up basis.

Where the IRS otherwise might step in, according to Handwerger, is if, in the terms of the agreement, it can be recast as an installment sale. That would occur if the IRS could argue that in the agreement's overall terms and economics, purchasing the remaining 60% would be, in some way, compelled or a virtual certainty. Then, the IRS could attempt to invalidate or undo the tax advantages related to 60% being delayed for the step-up.

In that case, the IRS could argue the “substance of the transaction over the form,” implying the deal is structured in a "tax-motivated” manner. The transaction would collapse from two steps to one, where 100% of the organization is being sold at the outset, the second 60% transaction being part of one overall installment sale agreement.

“This is known as the step-doctrine in tax law, where a series of steps are collapsed into one—the one that reflects the actual substance of the transaction,” says Handwerger. “It is interesting to note that the step doctrine is not a two-way street for the IRS. They can only go from many to one, not from one to many.”

For Handwerger, it’s difficult to see how the two parties structure the deal in two distinct phases to avoid the installment sale problem. It’s possible that the sale only covers 40% of the asset's ownership today, while the remaining 60% is bought through a right of first refusal.

“The asset of the franchise not being sold today—the remaining 60%—has to be included in Peter's taxable estate upon death if the step up is the desired goal,” Handwerger says. “That ruling was recently made very clear by the IRS with Rev. Rul. 2023-2, and those assets in the hands of the estate could be taxed at 40%, the highest rate for taxable estates, unless passing to Mrs. Angelos at Peter’s demise.” Assets passing to a spouse are not taxed at that time, deferred until the last to die, he adds.

Handwerger also notes that it may have been Rev. Rul. 2023-2 that led to the structure observed in this case. Before this ruling, estate planning for wealthy individuals often included using an intentionally defective grantor trust (IDGT). Gifting assets, such as ownership in an appreciating asset like real estate or a sports franchise, to this IDGT froze the value for estate tax purposes. The value at the date of the gift to the IDGT would be subjected to the estate tax, but the growth of the value of those assets after the gift would not be, resulting in excluding the appreciation henceforth from the estate tax with the “freeze.”

Aggressive tax planners believed that those gifted assets were eligible for the step-up. “The Revenue Ruling says “no” to that and is probably the right interpretation of the tax law here,” Handwerger says with some lament.

“This ruling caused many estate tax planners to immediately start considering swapping out assets in the trust for other assets of equal value to get the step-up for the assets being swapped out,” Handwerger says.

Another aspect of the taxes behind the deal lies with Angelos’ current residence. Should he no longer reside in Maryland, the team’s intangible assets could be in a state without state transfer or estate taxes. Maryland is the only state that levies the estate and inheritance tax, but 33  states have neither.

From Rubenstein’s position, there are also opportunities to reduce potential taxes. One of which is in Section 197 of the Tax Code. Intangible assets—patents, trademarks or goodwill—acquired in purchasing a limited partnership (in this case, the Orioles) can be deducted from earnings over the first 15 years of the acquisition.

A recent Forbes article suggests that at least 90% of the $1.7 billion price tag could be allocated to intangible assets, leading to roughly “$100 million a year in potential tax savings” for Rubenstein. This is possible because sports team ownership groups are considered “pass-through” entities that can share losses on their tax returns to reduce the taxable income from their other business ventures.

“That pass-through loss for many investors comes with a caveat in that not all pass-through losses are created equal,” Handwerger says.

Such losses can be classified as either ordinary or passive. Passive losses can offset passive income but not ordinary income. If an investor is not “active” as defined by IRS Regulations, the losses are considered passive. The rules on this are quite complex and often are behind many IRS audits of pass-through entities.

Regardless, as the O’s take to the diamond this spring, Handwerger is equally keen to see how the rest of this deal plays out.

“I’m looking for someone to give me a sneak peek at the agreement,” he says. “It has to be some pretty clever "tax-lawyering," and I would love to see it.”