When the time comes to relocate or retire and sell your dental practice, the taxes on the sale become a consideration. Making the wrong tax choice could leave you paying more in tax than necessary. Many dentists are not aware that it is possible to defer the tax owed for the sale of their practice until a later date and sometimes indefinitely.

The sale of your practice can have one of several income tax consequences depending on its form and the type of assets sold. If you sell depreciated dental equipment, any gain is subject to tax at the highest ordinary rates ranging up to almost 40%. If an individual rather than a corporation owns the real estate, gain equal to the previous depreciation is taxed at 25% and gain on the sale in excess of depreciation is taxed at 20%. If a corporation owns the equipment and real estate, all gain is taxed at the highest federal corporate tax rates plus Texas franchise tax. If the corporation is liquidated as part of the winding down of a practice, an additional tax will be owed on the liquidating dividend.

Most proceeds of the sale of dental equipment are subject to tax at the highest rates since little tax basis often remains as most equipment in a dental practice is written off in the year of purchase or depreciated over 5-7 years. A related tax trap for the unwary comes about by selling the assets in an installment sale. Generally in an installment sale gain is reported pro-rata as payments are received. Any gain up to the amount of depreciation previously taken however, is taxed in the year of sale rather than spread over a period of years. Because of the "depreciation recapture" rule, the tax due in the year of sale frequently exceeds the down payment on the sale, which can place the seller in a cash bind.

If the unnecessary loss of this large amount of money leaves you feeling squeamish, there is a less painful course of action. An alternative to paying the tax on a sale is to qualify the transaction as a tax-free exchange. If you satisfy the rules in a tax-free exchange and purchase like-kind property within six months of your sale, the tax is deferred sometimes indefinitely. The tax-free exchange has been an accepted part of tax law since 1921. The original policy concept behind the tax-free treatment is that the administrative burden of valuing the exchanged would not justify their increased tax revenue.

Congress in 1984 modified the internal revenue code section 1031 to include specific requirements to gain tax-free treatment. Since the rules in the revised section 1031 are so specific, it requires close attention to documentation and compliance to achieve a safe tax result. Over 90% of exchange transactions are classified as delayed exchanges with a qualified intermediary. In a delayed exchange the selling dentist enters into an exchange agreement with a qualified intermediary. By regulation the qualified intermediary is party to the exchange but can not be the dentist’s attorney, accountant, related party or person who has provided services to the dentist within the past two years. The qualified intermediary steps into the shoes of the seller by taking an assignment or transfer of the sales contract and holds the sales proceeds in trust for the seller’s benefit until replacement property can be purchased. The rules provide for two time periods in the transaction. The first time period is called the identification period and starts on the day the old (relinquished) property sale closes and ends after 45 days. The selling dentist is required to identify one to three properties as his replacement during the identification period. An alternate to the three property rule says that you can designate more than three properties as long as their aggregate value is less than 200% of the value of the relinquished property. The second time period is the replacement period, this also starts on the date of closing the sale on the relinquished property, and ends after 180 days. The selling/exchanging dentist must close on the purchase of his new property during the replacement period.

It is possible to have either a partially tax-free exchange or a totally tax-free exchange. In order to have a totally tax-free exchange, you are required to buy a more expensive property than you sold and not receive any unlike-kind property in the exchange. Dental equipment, real estate, and patient records are typically exchanged for like-kind property. You will have to pay tax on cash, net relief of debt and property, not of a like-kind, received in an exchange which is referred to as "boot." Since the sale of a professional practice or business is considered to be a sale of multiple assets, you need to allocate the sales price by category of asset and calculate the tax effect asset by asset.

Suppose Dr. Adams is interested in moving to another city and buying another dental practice using a IRC 1031 exchange, the following illustrates the allocation of his assets in both the selling and purchasing contracts:

** If needed you can change the values to match your own and Estimate the savings. The values are only estimates, actual values may vary.

In an ordinary sale transaction, the seller will calculate a tax liability on the excess of the sales proceeds over depreciated cost- some times call "adjusted basis." Depreciated cost is the original cost of the asset minus all depreciation previously deducted. Because the depreciated cost of the dental equipment is $10,000 and the selling price is $100,000, the taxable gain would be $90,000 if sold outright. Because the purchase value of the new dental equipment is $95,000, Dr. Adams is considered to receive $5000 in "Boot". Dr. Adams will pay tax on the $5000 of "Boot" rather than on $90,000 total profit thereby reducing his taxable income by $85,000 in the exchange.

Because the depreciated cost of the real estate is $200,000 and the selling price is $500,000 the profit would be $300,000 if sold outright. Because Dr. Adams is purchasing a replacement piece of real estate at $600,000, which is worth more than the selling price of $500,000 he will not be taxed on his profit of $300,000.

Patient records are not depreciated. Because Dr. Adams is purchasing patient records for $110,000, which is more than he is exchanging for his records priced at $100,000, he will not be taxed on the gain of the sale of $100,000 for patient records. In this example the tax rate for dental equipment is 40% because of the prior depreciation and the tax rates for real estate and patient records are each 20%.

Therefor Dr. Adams tax liability is summarized as follows: