Depreciation recapture

I have been in practice for over 30 years and am now planning to sell out and retire. I have owned my own office building for approximately 20 years. It was originally constructed at a cost of $300,000 for land and building. I now have negotiated for the sale of my practice and related real estate, with the real estate price set at $450,000. My accountant now tells me that much of the gain will not be taxed at a maximum rate of 20 percent due to "depreciation recapture." I told him that he is i

Mar 1st, 1998

Charles Blair, DDS

John McGill, MBA, CPA, JD

I have been in practice for over 30 years and am now planning to sell out and retire. I have owned my own office building for approximately 20 years. It was originally constructed at a cost of $300,000 for land and building. I now have negotiated for the sale of my practice and related real estate, with the real estate price set at $450,000. My accountant now tells me that much of the gain will not be taxed at a maximum rate of 20 percent due to "depreciation recapture." I told him that he is incorrect, since I know that the maximum tax rate on long-term capital gains is now 20 percent for federal income-tax purposes. Who is right?

He is. As a general rule, gains realized after May 6, 1997 that qualify as long-term capital gains are taxed at the maximum rate of 20 percent.

Unfortunately, there is an exception relating to the portion of the gain realized that relates to depreciation previously taken by you, otherwise known as "depreciation recapture." Depreciation recapture is taxed at a maximum rate of 25 percent, while the remaining portion of the gain is taxed at a maximum rate of 20 percent.

For example, assume the original $300,000 cost was allocated $50,000 to the land and $250,000 to the building. During the 20-year period that you held this property, you had claimed depreciation deductions totaling $125,000. This would leave a tax basis of $175,000 ($50,000 land plus $125,000 building). Upon the sale, the $125,000 of depreciation previously taken would be taxed at a maximum rate of 25 percent, while the $150,000 "true gain" ($450,000 selling price minus $300,000 original price) would be taxed at a maximum rate of only 20 percent.

I had a long-term capital gain on some stock that I sold in April and September, but all my other gain in 1997 came from investments that I held less than one year. In addition, I sold some stocks at a loss that I owned less than a year. Do any of my other gains qualify for the lower 20 percent, maximum-tax rate on long-term capital gains?

No. Only gains realized after May 6, 1997, that qualify as long-term capital gains, are taxed at a 20 percent rate. The assets that you sold in September qualify for long-term gain only if they were held more than 18 months.

If you show a net short-term loss for assets held for less than one year, you can use that net loss to offset your gain taxed at 28 percent first, before using any remaining loss to offset the gain taxed at 20 percent.

I have practiced as a sole proprietor (unincorporated) for 20 years. I always have been concerned that I did not get the same tax breaks as my incorporated colleagues, particularly on deducting medical insurance for me and my family. My accountant says that, under the new tax law, I`m able to fully deduct my family`s medical insurance. Is this correct?

No. Under the 1996 Insurance Portability and Accountability Act, the deduction for self-employed doctors` health insurance costs was immediately increased from 30 percent of eligible costs to 40 percent beginning in 1997. Beginning in 1998 and continuing through 2002, the deduction will be 45 percent. The percentage increases to 50 percent for 2003, 60 percent in 2004, 70 percent in 2005 and 80 percent in 2006.

Dr. Blair is a nationally known consultant and lecturer. 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 ($149 a year) and consulting information are available from Blair/McGill and Company, 4601 Charlotte Park Drive, Suite 230, Charlotte, NC 28217 or call (704) 523-5882.

More in Practice