A Home Run Only a Lawyer Could Love

Only lawyers would revel in the tax consequences of catching 755. For the initiated, the question is when you would pay taxes, not if.

The ball is estimated at $500K. Let's assume you keep it for 1 year, then sell it for $600K.

1. Do you pay taxes on it as income this year?

It is an "accession to wealth," not unlike winning the lottery, which is taxed (for simplicity's sake) as income no different from your paycheck. The problem with this idea is that the taxes alone would wipe out the entire salary of a person making up to $150K/yr.

This is not a new problem. Contest winners pay taxes on the prize as income for that year and have many times been forced to sell new cars and the like because they could not afford to pay the taxes. There are companies that do nothing but purchase such items from "lucky" distressed sellers.

Incidentally, though it seems a little unfair, I think that sweepstakes/contest winnings are the closest factual analogy to this case; the IRS would likely follow that guidance.

The second option is to treat this like an heirloom you get from a dead relative. You get the object, but you don't really have access to its value until you sell it. Thus, the "accession" does not happen until later on. Recognizing this, the IRS has chosen not to tax you on the object's value you when you get it, but rather to tax you on the profit once it is sold.

This analogy breaks down because, unlike an heirloom, which your relative paid for, you didn't pay for the ball 755. The price your relative paid is "basis." The price you get in excess of the basis is the "profit," which is taxable. The inability to ascertain the "basis" of ball 755 makes it extremely unlikely that the IRS would calculate taxes in this manner.

2. What tax do you pay when you sell the ball?

The first part is easy. If you paid tax on the ball as income last year, you pay tax only on the profit from the sale (on $100K). This is also true if the ball is considered like an heirloom. You.

The more interesting question is whether the profit is regular income (25% federal tax min.) or "capital gains" (15% tax bracket) like the sale of a house. I think most memorabilia, because they are physical assets, should get capital gains treatment. The only exception is where you are in the business of trading these things regularly -- then it is std. income.

This second answer helps one understand why it makes more sense to consider the ball as income in 2007, and then tax the sale of the ball separately in 2008. If you taxed it as income last year which determines the basis of the ball, you pay 1 kind of tax last year (income), and a second type of tax this year (cap gains).

If you pay all the taxes in 2008, you end up trying to figure out how to pay 2 different types of taxes on the same object arising out of one sale. Because you didn't value you the ball for tax purposes in 2007, you have no idea what it gained in 2008. So telling apart the basis (income) from the gain (cap gains) becomes damn near impossible.

(this would make 2 WSJ law blog posts in 2 days. Either I am getting dorkier, or the slow news cycle has sparked some creativity over there).