What do Obama and Don Sterling have in common?

Sounds like the beginning of a bad joke, doesn’t it? However, both have significant concerns about what is arguably the most significant tax loophole for upper income earners – the “stepped up basis” for heirs of appreciated property.

Currently capital gains are taxed at a top rate 23.8%. Thus, if a person buys an asset for $10 and then sells it later for $110, the seller is on the hook for income tax on the $100 gain for potential tax bill of up to $23.80.

However, if a person dies and leaves the asset to his or her children, no capital gains tax is ever paid on that asset and the cost or “basis” for the asset is reset to $110. If the children were to later sell the asset for $210, they would only pay income taxes on the change in price from the time they inherited the asset until when they sold it (i.e $210 – $110 = $100) not the entire appreciation of the asset over time ($210 – $10 = $200). No income taxes would ever be paid for that first $100 of capital gains accumulated by the family.

So what do Sterling and Obama have to do with this? Well, in yesterday’s State of the Union address Obama asked, “Let’s close the loopholes that lead to inequality by allowing the top one percent to avoid paying taxes on their accumulated wealth.”  Specifically, President Obama would change the tax code to require a person’s estate to pay taxes on any accumulated but unrealized capital gains at the time of a person’s death.

And what about Sterling?  One question many people had was why Sterling was so adamant about hanging on to his team when he was uniformly hated by his fans, his players, and the rest of the league following the release of recordings of him making racist comments. Well, Sterling had over 400 million reasons to hang on to his team. Having purchased the team for a mere $12.5 million back in 1981, by selling the franchise to Steve Ballmer last year for $2 billion, the tax bill on Sterling’s sale of the Clippers might come to as much as $470 million, although clever accountants will probably be able to whittle that down a bit. On the other hand, had the 80-year old Donald Sterling died while still owning the team, his heirs would have owed a grand total of $0 in capital gains tax on the franchise.

Under Obama’s proposed tax changes, the $470 million in capital gains tax would have to be paid either by Sterling when he sold or by his heirs when he died. Sterling would have no tax incentive to hold onto the team until his death. Of course, the chance of an Obama tax reform proposal passing under the Republican-controlled Congress is about the same as the Lakers winning the NBA title this year, but this is one tax loophole that deserves to be expelled from the league.