Tax Considerations when Buying or Selling a Dental Practice – Part 2
Tax Considerations when Buying or Selling a Dental Practice – Part 2
By Keith Dunnagan and Matthew Kirkpatrick
In Part 1 we introduced the potential tax considerations related to a practice transition sale and look at the differences between ordinary income and capital gains taxes. Today we start by looking at the tax considerations related to depreciated equipment and other assets.
5. IRC §1231 Property
Property used “in the trade or business” is not included in the IRC’s definition of a capital asset and therefore upon its sale would not be eligible for the preferential capital gains tax rate were it not for a special code section that allows a recharacterization of this sort of income. IRC §1231 allows for gains earned from the sale of property used in the trade or business which is held for greater than one year to be characterized as long-term capital gains.
6. IRC §1245 Recapture Tax
IRC §1245 recapture tax is a way for the IRS to recapture the depreciation deductions taken on personal property and in limited circumstances real property. To determine if IRC §1245 recapture tax applies, the “recomputed basis” must be calculated by adding the adjusted basis to the total of the deductions that have been taken. The difference between the adjusted basis and the recomputed basis is subject to IRC §1245 recapture and is taxed as ordinary income. Any amount realized beyond the recomputed basis is taxed as capital gains under IRC §1240 or §1231.
7. IRC §1250 Recapture Tax
IRC §1250 recapture tax is similar to that under IRC §1245 in that it is a way for the IRS to recapture deductions that have been taken on real property which is not IRC §1245 property. IRC §1250 applies the ordinary income tax to the amount realized that is attributable to the depreciation that has been deducted from the property in excess of straightline depreciation. Any gain beyond the excess depreciation is taxed as either IRC §1221 capital gains or as IRC §1231 gains.
8. Tax of Goodwill
Every practitioner knows that a functioning practice is worth more than the sum of its tangible assets. This additional value is often known as goodwill. “Goodwill is a capital asset.” (Better Beverages, Inc. v. United States (1980) 619 F.2d 424, 425 n. 2). This is good news for a practitioner selling a practice as it will be taxed at the lower capital gains rate. There are a couple of ways that this is accomplished.
As discussed above, IRC § 1231 allows gains from the sale of depreciable assets to be taxed at a capital gains rate. Sometimes goodwill is considered an amortizable asset under IRC §197 and therefore is a depreciable asset taxed at a capital gains rate under IRC §1231. However, if the goodwill is “created by the taxpayer” (meaning through the hard work and expertise of the practitioner) it is not depreciable under IRC §197(c)(2)(B) and must be characterized under IRC §1221(a)(2).
Therefore, one way or another, the sale of goodwill is taxed at a capital gains rate.
9. Tax of Non-Compete Covenants
The same cannot be said for the sale of a non-compete covenant. Neither the buyer nor the seller have an interest in allocating any more of the purchase price to a non-compete covenant than is necessary to ensure it is enforceable. The downside for the seller is that the “amounts received by a seller for a non-competition covenant are considered to be given as compensation for lost earnings and, as such, are taxable as ordinary income.” (Patterson v. C.I.R. (1987) 810 f.2d 562, 569). The downside for the buyer is that it must be depreciated over a 15 year period regardless of the duration of the non-compete period pursuant to IRC §197(a). This means a buyer could end up depreciating a non-compete for years after it ceased to have any force. Instead it would likely be better to allocate more of the purchase price to the capital assets.
We hope that you will find this Article helpful in your business. Please feel free to forward this Article on to anyone that you think may benefit from this information. As always, if you have any questions or comments, you can contact us at kbdunnagan@bpelaw.com or mjkirkpatrick@bpelaw.com or if you need a consultation for any legal issues, you can call our office at (916) 966-2260 for an appointment at our Gold River headquarters or our Lincoln satellite office.
This article is not intended to be legal advice, and should not be taken as legal advice. Every case requires review of specific facts and history, and a formal agreement for service. Please feel free to contact us if you need legal advice and are interested in seeing if we can help you
Tax Considerations when Buying or Selling a Dental Practice – Part 2
By Keith Dunnagan and Matthew Kirkpatrick
In Part 1 we introduced the potential tax considerations related to a practice transition sale and look at the differences between ordinary income and capital gains taxes. Today we start by looking at the tax considerations related to depreciated equipment and other assets.
5. IRC §1231 Property
Property used “in the trade or business” is not included in the IRC’s definition of a capital asset and therefore upon its sale would not be eligible for the preferential capital gains tax rate were it not for a special code section that allows a recharacterization of this sort of income. IRC §1231 allows for gains earned from the sale of property used in the trade or business which is held for greater than one year to be characterized as long-term capital gains.
6. IRC §1245 Recapture Tax
IRC §1245 recapture tax is a way for the IRS to recapture the depreciation deductions taken on personal property and in limited circumstances real property. To determine if IRC §1245 recapture tax applies, the “recomputed basis” must be calculated by adding the adjusted basis to the total of the deductions that have been taken. The difference between the adjusted basis and the recomputed basis is subject to IRC §1245 recapture and is taxed as ordinary income. Any amount realized beyond the recomputed basis is taxed as capital gains under IRC §1240 or §1231.
7. IRC §1250 Recapture Tax
IRC §1250 recapture tax is similar to that under IRC §1245 in that it is a way for the IRS to recapture deductions that have been taken on real property which is not IRC §1245 property. IRC §1250 applies the ordinary income tax to the amount realized that is attributable to the depreciation that has been deducted from the property in excess of straightline depreciation. Any gain beyond the excess depreciation is taxed as either IRC §1221 capital gains or as IRC §1231 gains.
8. Tax of Goodwill
Every practitioner knows that a functioning practice is worth more than the sum of its tangible assets. This additional value is often known as goodwill. “Goodwill is a capital asset.” (Better Beverages, Inc. v. United States (1980) 619 F.2d 424, 425 n. 2). This is good news for a practitioner selling a practice as it will be taxed at the lower capital gains rate. There are a couple of ways that this is accomplished.
As discussed above, IRC § 1231 allows gains from the sale of depreciable assets to be taxed at a capital gains rate. Sometimes goodwill is considered an amortizable asset under IRC §197 and therefore is a depreciable asset taxed at a capital gains rate under IRC §1231. However, if the goodwill is “created by the taxpayer” (meaning through the hard work and expertise of the practitioner) it is not depreciable under IRC §197(c)(2)(B) and must be characterized under IRC §1221(a)(2).
Therefore, one way or another, the sale of goodwill is taxed at a capital gains rate.
9. Tax of Non-Compete Covenants
The same cannot be said for the sale of a non-compete covenant. Neither the buyer nor the seller have an interest in allocating any more of the purchase price to a non-compete covenant than is necessary to ensure it is enforceable. The downside for the seller is that the “amounts received by a seller for a non-competition covenant are considered to be given as compensation for lost earnings and, as such, are taxable as ordinary income.” (Patterson v. C.I.R. (1987) 810 f.2d 562, 569). The downside for the buyer is that it must be depreciated over a 15 year period regardless of the duration of the non-compete period pursuant to IRC §197(a). This means a buyer could end up depreciating a non-compete for years after it ceased to have any force. Instead it would likely be better to allocate more of the purchase price to the capital assets.
We hope that you will find this Article helpful in your business. Please feel free to forward this Article on to anyone that you think may benefit from this information. As always, if you have any questions or comments, you can contact us at kbdunnagan@bpelaw.com or mjkirkpatrick@bpelaw.com or if you need a consultation for any legal issues, you can call our office at (916) 966-2260 for an appointment at our Gold River headquarters or our Lincoln satellite office.
This article is not intended to be legal advice, and should not be taken as legal advice. Every case requires review of specific facts and history, and a formal agreement for service. Please feel free to contact us if you need legal advice and are interested in seeing if we can help you