Source: https://www.bpelaw.com/tax-considerations-when-buying-or-selling-a-dental-practice-part-1/
Timestamp: 2020-05-25 07:17:28
Document Index: 494988574

Matched Legal Cases: ['art 1', 'art 1', '§1060', '§1016', '§1221', '§1221', '§1222', '§64', '§61', '§63', '§1']

Tax Considerations when Buying or Selling a Dental Practice – Part 1 | BPE Law
Tax Considerations when Buying or Selling a Dental Practice – Part 1
March 15, 2016 | Category: BPE Newsletter, Dental Law
Buying and selling a dental practice is not an uncommon occurrence for most practitioners. There are many issues affecting the costs and profits that are impacted by the Internal Revenue Code (IRC). Of course, both parties want to buy low and sell high. However, the purchase price is not always the end all be all of the negotiation. Often times it can be possible to pull out a greater after-tax-profit from a lower purchase price so long as the transaction is structured properly. This is where a savvy attorney and accountant can make a tremendous difference.
I. Objectives: Generally a seller will have to pay some combination of ordinary income tax, capital gains tax, recharacterized business capital gains tax, and depreciation recapture taxes. As a seller the goal is to push as much profit into a preferential capital gains tax rate as possible. The best way to do this is to allocate as little of the purchase price to the assets used in the trade or business and more towards goodwill.
As a buyer the goal is to allocate as much of the purchase price to assets in order to increase the basis in those assets held for the use in trade or business. More specifically, to depreciable assets with a short amortization schedule. This not only allows a buyer to deduct a greater amount of the purchase price as soon as possible, but it allows a buyer to have a smaller amount realized upon the asset’s eventual sale. The Internal Revenue Service (IRS) will respect a written contract agreeing on an allocation under IRC §1060(a) unless the Secretary of the IRS “determines that such allocation…is not appropriate.”
This basic conflict is what provides the groundwork when negotiating the sale of a practice.
II. Taxes on Sale of Property
A lot of these issues require an explanation of the various tax rates and capital gains that are assessed against gains and losses.
1. Gain / Basis / Adjusted Basis / Amount Realized
Gains on the sale of property are calculated by subtracting the adjusted basis from the amount realized.
The basis of property is typically the purchase price and is used as the benchmark to assess the gain or loss upon its sale or exchange. The “adjusted basis” under IRC §1016(a) is the basis as increased or decreased by any “expenditures…chargeable to the capital account” or “for exhaustion, wear and tear, obsolescence, amortization and depletion.” Basically, a property’s basis is increased by the cost of improvements, and reduced by the depreciation deducted each year.
The “amount realized” is the difference between the amount received from the sale of property and the adjusted basis of that property at the time of sale. The amount realized is the amount which will be taxed.
2. Ordinary Income
Most people know that ordinary income is taxed at the standard rates which currently are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% depending on your income bracket and filing status. The sale of a dental practice can quickly bump a seller into a steep tax bracket. Therefore, if possible, the goal is to push income into a lower capital gains tax rate.
3. Capital Gains and Rates
Congress has decided that to encourage investment in property and businesses lower taxes will be assessed on the sale of capital assets, which are defined in IRC §1221. Capital assets have a strange definition in that it is an exclusionary definition. IRC §1221(a) defines capital assets as “property held by the taxpayer…but does not include…” a variety of assets. This covers just about all of a taxpayer’s property with the biggest exclusion being business property. The capital gains rate is 0%, 15%, and 20%, depending on income bracket.
4. Long Term v Short Term Gains
The favorable capital gains rates only apply to “long term capital gains”. Those are defined in IRC §1222 as a “gain from the sale or exchange of a capital asset held for more than 1 year”. If the property is held for exactly one year or less, then any gain on the sale will be considered a “short-term capital gain”, classified as ordinary income pursuant to IRC §64, treated as “gain from the sale or exchange of property, which according to IRC §61(a)(3) is included in the definition of “gross income”, and then reduced by applicable deductions to arrive at taxable income in IRC §63(a) and taxed under the applicable filing status and brackets under IRC §1.