## Facts

- First Northwest Industries of America, Inc. bought the Seattle Supersonics NBA franchise in 1967 for $1,750,000, acquiring a bundle of franchise-related intangible rights.
- The Tax Court allocated the purchase price among rights, assigning $500,000 to a special expansion draft right and $250,000 to a right to share in 1968 NBA expansion proceeds; the remaining $1,000,000 was allocated to other continuing NBA membership rights (e.g., territorial exclusivity, participation in drafts, broadcasting and merchandising revenue sharing, and general league membership benefits).
- In 1970, the NBA expanded by adding three new teams; the resulting franchise sale proceeds were distributed among existing team owners, including the taxpayer.
- The taxpayer reported part of its 1970 distribution as a return of capital, reducing the proceeds by a portion of its $1,000,000 basis in the residual bundle of franchise-related rights.
- The Commissioner determined the taxpayer could not use basis to offset the 1970 proceeds because the new franchises’ rights were created by the league rather than transferred from existing owners.
- The Tax Court held expansion effectively reduced each existing team’s fractional share in certain league-wide rights (from 1/14 to 1/17) and allowed roughly $175,000 of basis to be recovered against the 1970 proceeds; the Commissioner appealed.

## Issues

1. Whether proceeds distributed to an existing NBA franchise owner from a later league expansion could be partially treated as a return of capital based on an alleged partial disposition of the owner’s intangible franchise rights.
2. Whether the reduction in an existing team’s proportional share of league-wide benefits due to expansion constitutes a recognizable sale or exchange of property permitting basis recovery.

## Decision

- The Ninth Circuit reversed the Tax Court and remanded.
- The court held the taxpayer could not reduce the 1970 expansion proceeds by any portion of its $1,000,000 basis in the residual franchise-rights bundle.
- The court concluded the expansion franchises received rights that were newly created within the league structure, not property interests transferred from existing teams.
- The Tax Court’s amortization treatment for the separately identified limited-life rights (special expansion draft and 1968 expansion proceeds) was not disturbed because it was not at issue on appeal.

## Legal Principles

- Basis recovery against amounts received requires a recognizable disposition (sale or exchange) of an identifiable property interest.
- A mere reduction in an owner’s proportional share of enterprise-wide benefits (dilution from adding participants) is not, by itself, a disposition of the owner’s preexisting intangible property.
- When payments to existing members arise from admitting new members and the new members’ rights are created rather than carved out of existing members’ rights, distributions to existing members are treated as taxable income rather than return of capital.

## Conclusion

The court held that cash distributed to an existing NBA team owner from the league’s expansion was taxable income because the expansion did not transfer any part of the owner’s existing franchise rights; it only changed the conditions under which those rights were enjoyed, so no basis in the residual franchise-rights bundle could be recovered against the proceeds.


First Nw. Indus. of Am., Inc. v. Comm’r, 649 F.2d 707 (9th Cir. 1981)