by Charles Blair, DDS and John McGill, MBA, CPA, JD
Another general practitioner and I own our practices separately, but we own our professional office building 50/50 through a real estate partnership. Our office building is currently paid off. Each of us is 57 years old, and we envision retiring in the next five years or so.
Unfortunately, our retirement plans are only partially funded. We have some nondental investors eager to purchase our office building. However, we are not eager to sell, because we could incur a large tax liability. This also may negatively affect the sale of our practice for a younger doctor in the future.
Do you think we should sell the office building now, refinance in order to free up funds to contribute to our retirement plans, or simply "stay the course"?
Your situation is fairly complex, so that a complete answer cannot be given without further information. However, we can provide a few general observations for your benefit.
First, we would be hesitant to recommend that you sell the office building at the current time to an outside investor. While the potential tax liability could be deferred through a Section 1031 tax-free exchange, you still would lose control of the office building.
Moreover, these outside investors would not be willing to lease the building back to you unless they could generate a substantial profit, which would significantly increase your rental costs. Accordingly, we feel that it would be wise to retain ownership of your professional office building at this time.
However, seriously consider refinancing your office to free up some tax-free cash. This cash can be invested in a defined-benefit pension plan, that allows tax-deductible contributions as high as $75,000 to $100,000, which can help doctors your age achieve a financially secure retirement, says Rob Haness, an enrolled actuary with PennSys, Inc. — (800) 557-3679 — a nationally known employee-benefit consulting firm.
The building rent charged to each of your separate practices then would be increased to cover the debt service on the refinanced office building, which would further reduce your federal and state income tax liabilities. We recommend that you seriously consider this approach, particularly since interest rates have declined recently, making refinancing an even more attractive alternative.
I am considering the sale of my professional practice in the near future. Recently, I discussed this with my CPA and he told me that I would be required to pay tax on all the gain from the sale immediately, regardless of when I received payment.
I told him that this did not seem to be right, since I thought I could report the gains on an installment basis, paying tax on them only as received. My CPA indicated that this was formerly the case, but the tax law had changed. Is he correct?
The Tax Relief Extension Act of 1999 amended Section 453 of the tax law, denying installment reporting on sales of businesses, but only for taxpayers reporting on the accrual basis. Since your practice should be eligible to remain on the cash method of reporting, this new tax-law provision should not affect you.
As such, you will be eligible to report the gain on the installment method, paying tax only as amounts are actually received. However, you are required to recapture previously taken depreciation deductions, on which gain remains immediately recognizable.
The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.
Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($177 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217 or call (704) 424-9780.