Most dental practice acquisitions are structured as asset purchases. The buyer forms a new entity, and that entity purchases the practice's equipment, supplies, patient records, and goodwill from the seller. Within that structure, the purchase agreement will state how the total price is allocated among the assets, and that allocation has tax consequences for both parties for years afterward.
How the price is divided
Section 1060 of the Internal Revenue Code requires the buyer and seller to allocate the price among seven classes of assets, in order, and to report the allocation on IRS Form 8594 with their tax returns for the year of sale. For a typical dental practice, the classes that matter are equipment and furniture, supplies, a non-compete agreement, and goodwill and other intangibles, such as the patient base and the practice's name.
Each category is treated differently. Equipment is depreciated, and in many cases it can be deducted quickly through Section 179 or bonus depreciation, both of which can apply to used equipment acquired from an unrelated seller. Goodwill, patient records, and non-compete agreements are intangible assets under Section 197 and are amortized evenly over fifteen years regardless of the length of the agreement.
The buyer and seller want different things
A buyer generally prefers more of the price assigned to equipment, because it can be deducted sooner. A seller generally prefers more assigned to goodwill, which is usually taxed at capital gains rates, rather than to equipment, where depreciation previously taken is recaptured as ordinary income. Amounts paid for a non-compete agreement are ordinary income to the seller and are amortized over fifteen years by the buyer, so neither side usually benefits from a large allocation there.
Because both parties file Form 8594, the allocation is typically set in the purchase agreement and reported consistently by both sides. An allocation that departs substantially from the actual value of the assets, for example an inflated value for aging equipment, is open to challenge.
Personal goodwill. In some sales, part of the goodwill belongs to the selling dentist personally rather than to the practice entity. This matters most when the seller's practice is a C corporation, and it is usually addressed early in the negotiation.
What to review before the allocation
The allocation is only as sound as the information behind it. Before agreeing to a price and its division, a buyer's review typically covers at least three years of the practice's financial statements and tax returns, monthly production and collections, the payer mix and PPO participation, the age and condition of the major equipment, and the terms of the lease. Accounts receivable are usually retained by the seller, which means the buyer's first several weeks of collections will be lower than the practice's history suggests. First-year cash flow reflects that gap.
State differences
Federal and state treatment may not match. Georgia, for example, does not follow federal bonus depreciation, so equipment that is deducted in full on the federal return may be depreciated over several years on the Georgia return. Both figures bear on what the allocation is worth to the buyer.
This is general information rather than advice for a specific transaction, and the right allocation depends on the facts of the sale. Our dental practice page describes how we work with dentists who are buying a practice.
This post is general information, not specific tax, accounting, or legal advice. Your situation may differ, so talk to us before acting on anything here.