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The Roster Depreciation Allowance and the NHL

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11-22-2012, 01:25 AM
  #1
Crumblin Erb Brooks
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The Roster Depreciation Allowance and the NHL

A peculiarity of the tax code related to owning a professional sports team is the Roster Depreciation Allowance, which allows those who purchase professional sports teams to depreciate the entire cost of the franchise over 15 years\. When talking about owners "hiding" profits during this lockout, this should be the first topic being brought up.

Introduced by Bill Veeck when he purchased the Cleveland Indians in the 1940s, the logic was that when he purchased the team, he assigned the vast majority of value of the team to "intangible player assets", their players. Because this is an intangible asset, he depreciated this value over a number of years. This argument is flawed at best, assuming that the intangible value of players only declines when one purchases a team, and never increases. In the paper linked below, it is compared to how farmers are apparently allowed to depreciate livestock as they become less useful. Again, the analogy is flawed, livestock arent people, and players have choices. Free agency and trades muddle the idea even further.

If you still follow me, this argument means that owners are allowed to double count (at least with regards to tax liability) costs related to players' salaries, as an actual expense (what the owner pays the players in any given year) and as a depreciation of the initial cost of the franchise.

http://econ.la.psu.edu/~ecoulson/veeck.pdf

This scholarly article details the RDA much better than I can, and it has some (dated, and frankly, ********) comments from Caps owner Ted Leonsis on the topic. He claims that the Caps make no money and doesnt have to worry about this. But losses and gains are passed through to the owner with regards to tax liability/benefit, so it can offset other income the owner has. The comparative static analysis in the paper isnt an easy read, but the introduction and conclusion are easy enough understand.


Some questions I have
1) An interesting note in the paper was that the NHL and NBA didnt lobby for/against it when it was amended in 2005, although the NFL and MLB did. Was this a case of letting the bigger leagues take the lead or is Leonsis right in that it doesnt really affect teams that lose money?
3) Is there any comparable tax benefit for Canadian teams? I assume not.
4) The paper only talks about this with regards to tax implications, but when teams report that they are losing millions, is this included in that calculation? I guess it is impossible to tell without owners opening up their books, but is this something an auditor for the NHLPA can call ******** on?
4) Any other comments or insight on the topic? BoH is pretty good about being knowledgeable about this stuff.

From what I have read on the topic, it is complete bull. They are essentially depreciating a cost that simply does not exist. As a taxpayer (albeit, a small one), I am annoyed as this is just another way the uber-rich shelter their taxable income, especially where Americans just came off of a political season filled with debates on closing tax loopholes. It should be noted that the RDA allowed was INCREASED in 2005 to allow 100% depreciation of the purchase price over 15 years from 50% of the purchase price over 5 years, thanks again George W!

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11-22-2012, 11:07 AM
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CGG
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Very good points made here about ownership of professional sports teams, and why it can attract brilliant billionaires to what seems to be a money-losing venture.

I'll go through a rough example that might help illustrate the true value of "money-losing" sports teams:

- Buy a team for $100 million
- The team earns pre-tax revenue of $5 million a year
- The team depreciates virtually all of the purchase price over the 15 year period, as explained in the report
- The team sells in 15 years for $150 million

Before getting into taxes, this team generates $5 million a year in cash, or $75 million over the 15 year hold period.

If there were no "Roster Depreciation" loop hole, the owner would basically have to pay taxes on $5 million a year. Using a rough 35% tax rate that would work out to $1,750,000 per year in taxes, or $26.25 million in taxes over 15 years. Then when he sells the team he realizes a $50 million capital gain, paying roughly 20% on that, or $10 million in taxes. Total taxes over 15 years are $36.25 million.

Along comes the Roster Depreciation Allowance. The owner depreciates his $100 million investment in the team, even though essentially everyone knows the value will go up over time, not down. $100 million in depreciation over 15 years works out to $6.5 million a year (rough numbers) so now the owner shows a $1.5 million loss each year instead of a $5 million gain.

Keep in mind he still pockets the $5 million in cash the team generates each year, while claiming a $1.5 million loss.

When he sells the team he pays capital gains taxes on the difference between the sale price ($150 million) and the net book value of the asset ($0, since it has been depreciated). Now he has a $150 million gain, but pays a much lower tax rate on this (around 20%?) so the tax bill at sale is $30 million.

This does a few advantageous things for the owner:

(1) Taxes are basically deferred. The owner pays no income tax at all on the team until it is sold.
(2) Taxes are minimized. Basically his entire tax bill is capital gains since there is no annual "income" due to depreciation. Capital gains have a lower tax rate (for now) in both the US and Canada.
(3) He can take the $1.5 million loss from the team, and roll it up to a personal level to offset $1.5 million in net income from other businesses, reducing his non-sports-team tax bill by roughly 35% of $1.5 million, or $525,000. That works out to a $7.8 million savings on taxes that he otherwise would have had to pay over the 15 years.

Overall, with the Roster Depreciation Allowance, the owner is going to pay $30 million in taxes 15 years from now, while saving $7.8 million in taxes from other ventures. Net $22.2 million in taxes, and it is essentially all back-dated. The NPV of that is minimal. If there were no RDA, he would have to pay $36.25 million over the same 15 years, and pay an annual amount of at least $1.75 million.

The owner makes out about $14 million better off because of this scam.


Rough numbers, rough tax rates, assumes owner has income from other sources, blah blah blah.

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11-22-2012, 12:50 PM
  #3
kdb209
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And before anyone asks, the Forbes' Operating Income numbers (and all other team profit/losses numbers I've seen) do NOT include that depreciation - ie RDA is not being used to claim inflated losses. Those numbers are EBITDA - Earnings before Interest, Taxes, Depreciation, and Amortization.

And, again before anyone asks, this has nothing to do with, nor has any impact on HRR.

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11-24-2012, 06:27 PM
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Crumblin Erb Brooks
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Quote:
Originally Posted by CGG View Post
Very good points made here about ownership of professional sports teams, and why it can attract brilliant billionaires to what seems to be a money-losing venture.

I'll go through a rough example that might help illustrate the true value of "money-losing" sports teams:

- Buy a team for $100 million
- The team earns pre-tax revenue of $5 million a year
- The team depreciates virtually all of the purchase price over the 15 year period, as explained in the report
- The team sells in 15 years for $150 million

Before getting into taxes, this team generates $5 million a year in cash, or $75 million over the 15 year hold period.

If there were no "Roster Depreciation" loop hole, the owner would basically have to pay taxes on $5 million a year. Using a rough 35% tax rate that would work out to $1,750,000 per year in taxes, or $26.25 million in taxes over 15 years. Then when he sells the team he realizes a $50 million capital gain, paying roughly 20% on that, or $10 million in taxes. Total taxes over 15 years are $36.25 million.

Along comes the Roster Depreciation Allowance. The owner depreciates his $100 million investment in the team, even though essentially everyone knows the value will go up over time, not down. $100 million in depreciation over 15 years works out to $6.5 million a year (rough numbers) so now the owner shows a $1.5 million loss each year instead of a $5 million gain.

Keep in mind he still pockets the $5 million in cash the team generates each year, while claiming a $1.5 million loss.

When he sells the team he pays capital gains taxes on the difference between the sale price ($150 million) and the net book value of the asset ($0, since it has been depreciated). Now he has a $150 million gain, but pays a much lower tax rate on this (around 20%?) so the tax bill at sale is $30 million.

This does a few advantageous things for the owner:

(1) Taxes are basically deferred. The owner pays no income tax at all on the team until it is sold.
(2) Taxes are minimized. Basically his entire tax bill is capital gains since there is no annual "income" due to depreciation. Capital gains have a lower tax rate (for now) in both the US and Canada.
(3) He can take the $1.5 million loss from the team, and roll it up to a personal level to offset $1.5 million in net income from other businesses, reducing his non-sports-team tax bill by roughly 35% of $1.5 million, or $525,000. That works out to a $7.8 million savings on taxes that he otherwise would have had to pay over the 15 years.

Overall, with the Roster Depreciation Allowance, the owner is going to pay $30 million in taxes 15 years from now, while saving $7.8 million in taxes from other ventures. Net $22.2 million in taxes, and it is essentially all back-dated. The NPV of that is minimal. If there were no RDA, he would have to pay $36.25 million over the same 15 years, and pay an annual amount of at least $1.75 million.

The owner makes out about $14 million better off because of this scam.


Rough numbers, rough tax rates, assumes owner has income from other sources, blah blah blah.
Thank you for the example, I missed the capital gains part that occurs when he sells the team. The 15 year rule is interesting, as it gives strong motive for an owner to sell the team when his RDA is all used up.

To kdb, obviously an "expense" has nothing to do with calculating revenue. And arent the Forbes numbers' estimates anyways? As I said, Im sure the PA auditors arent stupid and are aware of this when assessing teams' financial documents. But when owners claim that they are losing money, Im sure they are crossing their fingers behind their back with this in mind.

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11-25-2012, 08:49 AM
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barneyg
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Quote:
Originally Posted by CGG View Post
When he sells the team he pays capital gains taxes on the difference between the sale price ($150 million) and the net book value of the asset ($0, since it has been depreciated). Now he has a $150 million gain, but pays a much lower tax rate on this (around 20%?) so the tax bill at sale is $30 million.
I don't know the specifics of the US tax code but in Canada, the tax implications of buying/selling a team would be dependent on the legal structure of the deal i.e. whether the buyer bought the actual assets of the team or the shares of the holding company that holds the team. It's actually a pretty standard tax problem in Canadian tax.

If the buyer bought the assets, he would benefit from a similar (not identical) depreciation expense during x years but there would be a recapture of CCA (i.e. the depreciation expense would be reversed) at the sale. So taxes would be deferred but not minimized, and it would be tougher for the owner to use the losses from the hockey team to offset profits from other businesses. (Canadian rules are more stringent than US rules on that, although there are workarounds.)

If the buyer bought shares he could not depreciate anything but would not be taxed on a big capital gain at the sale. So none of the positive impacts you mentioned would apply.

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11-25-2012, 01:51 PM
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thinkwild
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Perhaps this would work well in a discussion topical in american politics of something best done as a tax code re-write to remove deductions rather than raise taxes on the rich?

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