The Ultimate Guide to Tax Planning when Selling Your Dental Practice: Insights from Cecil Staton of Arch Financial Planning

Selling a dental practice is a significant milestone in a dentist’s career. It marks the culmination of years of hard work and dedication, but it also comes with complex tax implications that can impact your financial outcome. Understanding the tax consequences of selling your dental practice is crucial for maximizing your profits and minimizing your tax liability. In this comprehensive guide, we’ll explore the critical tax considerations, strategies, and implications involved in the sale of a dental practice.

Arch Financial Planning is a dental-focused financial advisor that helps dental practice owners with dental practice sales and dental practice transitions. Be sure to read our guide and hire the right team of advisors who can assist with the sale of the practice you’ve built to empower your retirement plan. 

Be sure to hire a financial advisor, accountant, and broker who will only represent you and help you through your dental practice transition. Having these advisors on your side can help you secure the highest practice value.

Tax Implications of Selling Your Dental Practice:

Asset Sale vs. Stock Sale: One of the first decisions you’ll need to make when selling your dental practice is whether to structure the sale as an asset sale or a stock sale. An asset sale involves selling individual assets of the practice, such as equipment, patient records, and goodwill. In contrast, a stock sale involves selling the ownership interest in the practice entity. The tax consequences vary depending on the structure chosen, with stock sales typically resulting in more favorable tax treatment for the selling dentist.

Long-Term Capital Gains Tax Rates: The dental practice sale may result in long-term capital gains tax treatment with specific criteria. Generally, assets held for more than one year are considered long-term assets, and the gains from their sale are subject to preferential capital gains tax rates. Selling dentists may benefit from lower tax rates on long-term capital gains than ordinary income tax rates, resulting in potential tax savings. It’s important to consider not just federal income taxes but also any state income taxes.

Consideration of Real Property: If your dental practice owns real property, such as the building where the practice operates, selling this real estate can have significant tax implications. Depending on the length of ownership and appreciation in value, the sale may result in capital gains taxes. 

Check with your financial advisor about recapturing depreciation. The depreciation you’ve taken against the building all these years has reduced your tax basis. For example, if you purchased a building for $500,000 and took $250,000 of depreciation expenses, your basis might reduce to $250,000. If you sell the building for $1,000,000, your capital gain would be the sale price ($1,000,000) minus your new basis ($500,000 purchase price – $250,000 depreciation = $250,000) equals your taxable gain of $750,000. 

Specific tax strategies, such as a 1031 exchange or installment sale, may be available to defer or minimize the tax impact of selling real property.

Treatment of Goodwill: Goodwill is an intangible asset representing the value of a dental practice’s reputation, patient base, and brand recognition. When selling a dental practice, the portion of the sale price attributable to goodwill is subject to capital gains tax treatment. Proper valuation and allocation of goodwill are essential for determining the tax consequences of the sale and maximizing tax efficiency.

Entity Structure Considerations: The entity structure of your dental practice, such as a C corporation or an S corporation, can impact the tax consequences of selling the practice. For example, selling assets held in a C corporation may result in double taxation at the corporate and individual levels, whereas selling assets held in an S corporation allows for pass-through taxation, potentially reducing overall tax liability for the selling dentist. 

Most buyers prefer an LLC taxed as an S Corporation or a C Corporation rather than a sole proprietorship since the practice is owned by a separate entity and separate tax ID rather than directly by the doctor and their tax ID. If you plan to sell in a few years, consider asking your advisors if forming a Limited Liability Company (LLC) is better than a sole proprietorship. 

Patient Records and Confidentiality: When selling a dental practice, it’s essential to consider the treatment of patient records and maintain confidentiality throughout the sales process. The transfer of patient records must comply with HIPAA regulations and state laws governing patient confidentiality. Failure to properly handle patient records can result in legal liabilities and reputational damage for both the selling dentist and the purchasing party.

Installment Sale Option: An installment sale allows the selling dentist to spread the recognition of taxable gains over multiple tax years, providing potential tax deferral benefits. Installment sales can be particularly advantageous for sellers looking to minimize the immediate tax impact of the sale or manage their tax liability over time. However, sellers should carefully consider the risks and requirements associated with installment sales, including potential interest charges and default provisions. The taxation process becomes more nuanced when selling a dental practice through an installment sale, whereby the sale proceeds are received over multiple years. 

In an installment sale, the seller recognizes income proportionally to the payments received yearly rather than all at once. This can reduce the seller’s immediate tax burden by spreading the taxable income over several years. However, it’s crucial to note that interest in the installment payments is typically taxed as ordinary income. Additionally, if the seller financed part of the sale and the buyer defaults on payments, the seller may need to recognize the gain on the unpaid balance. Thus, while installment sales offer flexibility in managing tax liabilities, careful planning and consultation with a tax advisor are essential to optimize the tax consequences of selling a dental practice in this manner.

Goodwill of The Practice: Goodwill, in the context of selling a dental practice, refers to the intangible value associated with the reputation, patient base, brand recognition, and ongoing relationships established over time. It represents the expectation of future earnings and the ability of the practice to generate revenue beyond the tangible assets it possesses.

In the sale of a dental practice, goodwill plays a crucial role in determining the overall value of the practice. Buyers are often willing to pay a premium for practices with a strong reputation, loyal patient base, and established brand, as these factors contribute to the potential for continued success and profitability.

Goodwill can be categorized as personal goodwill or practice goodwill:

1. Personal Goodwill: Personal goodwill is associated with the selling dentist’s individual reputation, skills, and relationships. It encompasses the trust and loyalty built with patients over the years and is not transferrable to a new owner. Personal goodwill is typically not included in the sale price of the practice and is retained by the selling dentist.
2. Practice Goodwill: Practice goodwill, also known as enterprise goodwill, is the value attributed to the practice entity, independent of the selling dentist. It includes factors such as the location of the practice, the quality of staff, the strength of referral networks, and the overall reputation of the practice in the community. Practice goodwill is transferrable to a new owner and is typically included in the sale price of the practice. Valuing goodwill accurately is essential in selling a dental practice to ensure a fair and equitable transaction for both the seller and the buyer. 

Goodwill valuation approaches typically include the following: 

• Income approach: Based on the future earning potential of the practice, taking into account historical revenue and projected growth.
• Market approach: Comparing the sale price of similar dental practices in the market to assess the value of goodwill.
• Asset-based approach: Calculating the value of goodwill based on the difference between the total sale price and the tangible assets of the practice.

Proper valuation and allocation of goodwill are critical for tax purposes and financial reporting requirements. Both parties involved in the sale need to agree on the treatment of goodwill in the sale agreement to avoid disputes and ensure a smooth ownership transition.

Consultation with a Financial Advisor: Given the complexity of tax considerations in selling a dental practice, consulting with a qualified financial advisor is highly recommended. A financial advisor can provide personalized guidance, help structure the sale to optimize tax efficiency, and identify available tax strategies to minimize tax liability. 

At Arch Financial Planning, we help dentists nationwide. We’re financial advisors who can guide you through practice transitions and help you build the right team. 

In conclusion, selling a dental practice involves complex tax implications that require careful planning and consideration. By understanding the tax consequences of the sale, leveraging available tax strategies, and consulting with a knowledgeable tax advisor, selling dentists can maximize their profits and minimize their tax liability. Whether structuring the sale as an asset sale or stock sale, considering real property, allocating goodwill, or navigating entity structure considerations, proactive tax planning is essential for a successful and tax-efficient transition.

For personalized guidance on navigating the tax consequences of selling your dental practice, contact Arch Financial Planning, LLC, where our team of experienced advisors specializes in serving the unique needs of dental professionals.

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