by Charles Blair, DDS and John McGill, MBA, CPA, JD
Currently, another doctor and I practice as sole proprietors together in the same facility under a solo-group arrangement. We are each carrying $500,000 of term life insurance on the other doctor, in the event one of us meets an untimely death.
We are six weeks away from moving into a new building, the cost of which will total $700,000 (land, building, and equipment). We are considering taking out another $350,000 of life insurance per doctor. Should one of us die, the other doctor would own the practice and building, and our spouses would not have to become involved in the transfer and sale. The building and land are owned through a limited liability company. Each doctor owns a 50 percent interest in the LLC.
Do you favor maintaining this buy/sell life insurance coverage, or internally financing the buyout?
In most cases, we recommend using an internally financed buyout, especially for real estate purposes. Since your new building is presumably debt-financed, if either partner dies, the other would be due only 50 percent of the total equity in the property (value of the profit, less debt). Typically, upon the death of a partner, the real estate is refinanced under a new mortgage of sufficient size to allow the payout of the deceased doctor's equity in the property. Thereafter, the rent charged by the LLC to the practices utilizing the facility is adjusted so that the rental payments received will fully cover the new debt service. In this manner, the real estate buyout can be accomplished without the use of buy/sell life insurance.
The answer is not as clear-cut with respect to the practice buyout. Many doctors elect to purchase the other doctor's practice, assimilate as much of the full-fee patient base as possible into their practice, and sell off the remainder to another doctor. The deceased doctor's estate then can be paid full value for the practice by the purchasing doctor. The purchaser does this out of the additional income generated from the patient base purchased, as well as the proceeds from the sale of the remaining practice assets. Alternatively, the doctors could elect to provide instant liquidity for the buyout through cheap term life insurance coverage.
Recently, I attended an asset-protection seminar put on by an attorney and a CPA who were in the business of selling asset-protection trusts. At the seminar, they indicated that I could set up a trust and transfer my equipment into the trust at no tax cost, and then begin depreciating the equipment all over again in order to create more deductions to offset my income.
My CPA says this won't fly. Who is right? Your CPA.
As a general rule, a tax-free transfer of assets into another entity — such as a trust, partnership, or corporation — does not result in an increase in the basis of the equipment transferred and, therefore, does not allow depreciation deductions to begin all over again. Rather, in a tax-free transfer, the equipment retains the same tax basis as it did in your hands. While future depreciation is allowed, it is only to the extent of the remaining tax basis, and not the assets' fair market value.
The IRS recently cracked down on abusive trust tax shelters such as this in the United States vs. Estate Preservation Services, 202 F. 3rd 1093, 85 A.F.T.R. 2nd 603 (9th Circuit — 2000).
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.