First Northwest Industries of America, Inc. v. Commissioner

The taxpayer (plaintiff) purchased the Seattle Supersonics, a basketball team that became part of the National Basketball Association (the NBA), for $1,750,000. By purchasing the team, the taxpayer acquired 13 rights, including franchise rights to participate in the NBA and to be the exclusive NBA owner in the Seattle area, the right to participate in an expansion draft, and the right to share in the NBA’s expansion proceeds. The United States Tax Court allocated $500,000 of the taxpayer’s purchase cost to the right to participate in the expansion draft and $250,000 of the purchase cost to the right to share in the expansion proceeds, leaving $1,000,000 of the purchase cost for the 11 remaining rights, including the franchise rights. Years later, the NBA expanded by creating and selling three new teams, increasing the number of NBA teams from 14 to 17, and distributed the proceeds among the existing owners, including the taxpayer. The taxpayer subtracted its basis when calculating its gain from the expansion proceeds. The Commissioner of Internal Revenue (the Commissioner) (defendant) determined that the taxpayer could not subtract its basis from its gain because the rights given to the new team were created, not transferred from the existing owners to the new owners. In particular, the Commissioner argued that the taxpayer’s franchise rights were not transferred to the new owners. The United States Tax Court reversed the Commissioner and held that the taxpayer could subtract its basis in the rights it had lost when the NBA expanded. To calculate the basis, the tax court argued that the taxpayer had previously held a one-fourteenth interest in the 11 unallocated rights associated with owning an NBA team but now held a one-seventeenth interest. This meant that the basis that the taxpayer could withhold was the proportion of the taxpayer’s interest that had been transferred to the new owners, approximately $175,000 out of the taxpayer’s remaining $1,000,000 purchase cost. The Commissioner appealed.