Selling a Medical Practice Building: The Real Estate Exchange and the Practice Sale

Two sellers, two sales: the practice entity sells the practice and your real estate entity sells the building

Most physicians own the practice in a professional corporation or LLC and the building in a separate entity that leases it to the practice. That separation is what makes the exchange possible, because section 1031(a)(1) covers "real property held for productive use in a trade or business or for investment," and the building entity has held its property for exactly that.

The practice sale is a different transaction with a different seller. Equipment, records, the workforce, a non-compete and goodwill are not real property under Reg. section 1.1031(a)-3, so none of that price can go into an exchange.

If the building sits inside the practice entity itself, that entity is the only taxpayer that can exchange it, and the replacement property has to be acquired by the same entity. Exchanges inside S and C corporations covers the extra steps.

The purchase price allocation decides how much of the deal can be deferred

When the same buyer acquires the practice and the building, section 1060 requires the price to be allocated among seven asset classes by the residual method. The Form 8594 instructions put buildings, land and equipment in Class V, section 197 intangibles such as a non-compete in Class VI, and goodwill and going concern value in Class VII. Both buyer and seller file the form.

The incentives pull apart. You want value on the building, where it can be deferred; a buyer often prefers value on equipment it can depreciate quickly. Section 1060(a) makes a written allocation "binding on both the transferee and transferor unless the Secretary determines that such allocation (or fair market value) is not appropriate," so negotiate it as hard as the price.

Goodwill has its own question: whose is it? In a 1998 decision (110 T.C. 189) the Tax Court held that "personal relationships of a shareholder-employee are not corporate assets when the employee has no employment contract with the corporation." Whether goodwill is personal to you or belongs to the practice changes who reports the gain, and in a C corporation whether it is taxed twice.

Sell the building with the practice, or keep it and lease it to the buyer

Selling to the practice buyer at the same closing is the simplest path: the building's proceeds go to the qualified intermediary and the practice proceeds go to the practice entity. Keeping the building and signing a new lease with the buyer gives you rent now and, often, a more valuable property later, because investors price a building with a signed tenant differently from an owner-occupied one.

If you will keep referring patients to the buyer, for example as its employee, and the buyer furnishes designated health services, your lease is a financial relationship under the physician self-referral rules. The office-space exception in 42 CFR 411.357(a) requires a signed written lease of at least one year, space that is reasonable and used exclusively by the tenant, and rent "set in advance" and "consistent with fair market value," not based on the volume or value of referrals. The medical office property guide goes further into how buyers underwrite those leases.

Do not sell the building to an entity you control. Section 1239 treats gain on depreciable property sold between related persons, including a corporation or partnership more than 50% owned by you, as ordinary income, and section 1031(f) undoes an exchange with a related party if either side disposes of its property within two years.

Worked example: a $1,500,000 practice sale and a $2,400,000 building

These figures are hypothetical. A dentist's LLC owns the building, worth $2,400,000 with a $600,000 adjusted basis. Her professional corporation sells the practice to a group for $1,500,000: $200,000 for equipment, $100,000 for a non-compete and $1,200,000 for goodwill.

• Practice sale: equipment gain up to prior depreciation is ordinary recapture under section 1245, and how the non-compete and goodwill are taxed depends on who owns them and the entity type. None of the $1,500,000 can be exchanged.
• Building sold to the group at the same closing for $2,400,000: an $1,800,000 gain, fully deferred if the LLC reinvests the full net proceeds and replaces any debt within 180 days.
• Building kept and leased to the group for ten years at fair-market rent: no gain now, rental income taxed each year, and a later sale to an investor that can still be exchanged.
• Allocation pressure: every $100,000 the buyer moves from the building to equipment is $100,000 less that can be deferred. Run your own numbers with your CPA.

Time the two closings against the exchange clock, not the other way round

Under Reg. section 1.1031(k)-1(b)(2), the 45-day identification period and the 180-day exchange period start on the day the building transfers, and the exchange period ends sooner if your tax return for that year is due first. A practice closing that slips does not move the building's clock if the building has already closed.

Practice sales to health systems and investor-backed groups can take months of credentialing and diligence. If the building sale is ready first, consider closing it on its own with a lease back to your practice, so the exchange clock runs while the practice deal finishes; selling to the practice that will rent from you covers the leaseback mechanics.

Sign the exchange agreement with the intermediary before the building closes. Any cash from the building that reaches your account is boot.

Where the building proceeds can go once you stop practicing

Many physicians selling a practice want income without a tenant to manage. Healthcare and medical office interests in Delaware statutory trusts qualify as like-kind replacement property under Rev. Rul. 2004-86, and traditional DST exchanges can close on a short timeline when the practice deal compresses the calendar.

Medical office remains a specialized asset class: tenant credit, reimbursement changes and lease rollover all affect income, and DST interests cannot be sold easily before the sponsor sells the property. Spreading proceeds across more than one property type reduces dependence on any one of those.