Tax Considerations for Selling a Medical Practice: Allocation of the Purchase Price

Selling a medical practice is a significant decision with substantial financial and tax implications for both the seller and the buyer. One of the most critical aspects of the transaction is the allocation of the purchase price among the various assets of the practice. This allocation not only determines the tax liability for the seller but also affects the buyer’s future deductions. Because of its impact on both parties, the allocation of the purchase price is often a key negotiation point in the sale.

Example: Sale of a Medical Practice for $1 Million

Dr. Smith is selling their medical practice for $1 million. Below is an example of how the purchase price could be allocated in a way that is favorable to the seller: 

Asset Category Allocation Tax Implications for the Seller

Tangible Assets $50,000 Ordinary income due to depreciation recapture.

Goodwill $800,000 Taxed as long-term capital gains (lower tax rate).

Non-Compete Agreement $100,000 Taxed as ordinary income.

Patient Records & Files $50,000 Treated as a capital asset, taxed as capital gains.

Total Purchase Price $1,000,000 Mixed tax treatment based on allocation.

Key Points in This Allocation:

Goodwill ($800,000):

• This represents the majority of the purchase price.
• Favorable for the seller as it is taxed as long-term capital gains, typically at a lower tax rate (e.g., 20% plus any applicable state taxes).
• The buyer can amortize this amount over 15 years, providing tax deductions over time

Tangible Assets ($50,000)

• Includes equipment, furniture, and other physical property.
• The seller is subject to depreciation recapture, taxed as ordinary income. For example, if the seller had claimed $30,000 in depreciation, they would pay ordinary income tax on that amount.

Non-Compete Agreement ($100,000):

• While this provides immediate cash for the seller, it is taxed as ordinary income, which could mean a higher tax rate than capital gains.

Patient Records ($50,000):

• Allocated as a capital asset and taxed as long-term capital gains for the seller.

Favorable Allocation for the Seller

From a tax perspective, the seller prefers:

• A higher allocation to goodwill, which is taxed as capital gains.
•  A lower allocation to tangible assets to minimize depreciation recapture.
• A lower allocation to the non-compete agreement to reduce ordinary income taxation.

Tax Implications for the Buyer

Higher allocations to tangible assets and the non-compete agreement provide faster deductions through depreciation and amortization.

• The goodwill allocation, though amortizable over 15 years, ties up a significant portion of the purchase price in long-term deductions.

Potential Buyer Counterproposal:

• Tangible Assets: $200,000
•  Goodwill: $700,000
•  Non-Compete: $100,000

This shifts some deductions into categories that benefit the buyer in the short term but may not align with the seller’s tax goals.

In the example, the seller’s favorable allocation minimizes ordinary income taxes by prioritizing goodwill. However, the buyer may push for a different structure to optimize their deductions. Negotiation is key, and both parties should engage tax and legal professionals to achieve a balance that aligns with their financial goals while complying with IRS rules.