Jose is a 55-year-old dentist and business owner in California who, for many years, owned a major dental practice. As he considers his retirement plan, he decides to sell his practice to fund the next phase in his life. The dental practice is in good shape but needs a refreshed marketing strategy and capital improvements to bring the next generation of customers.

Selling the dental practice now will help Jose avoid an outlay of capital and help reduce his responsibilities in retirement.

After putting his practice on the market, he accepts an offer of $2,500,000. The dental practice’s adjusted basis is $1,000,000 and the selling expenses associated with the transaction are $50,000 resulting in a gain of $1,450,000. The dental practice’s property is not subject to a mortgage.

Comparing options: Structured Installment Sale vs. Lump Sum

During the sales process, Jose consulted with his legal, tax, and financial advisors who advised that he should receive the proceeds in a Structured Installment Sale. This was the best option for Jose because he didn’t need the sale proceeds in full immediately, and this structure would defer and reduce associated capital gain, net investment income and state income taxes.

He structures his $2,500,000 sale to be payable as follows: $183,570 payable in equal amounts for 20 years per the Purchase and Sale Agreement.*

If Jose had received the proceeds in full at the time of the sale, he would have to pay close to $243,500 in federal capital gain taxes (at a marginal 20% federal capital gains rate, as well as about another $45,600 due to the 3.8% net investment income tax. Additionally, since Jose is a resident of California which has graduated tax rates depending on income level, he would be subject to higher rates resulting in over $142,000 of associated state income taxes.

However, if he utilizes a Structured Installment Sale, he will pay approximately $5,383 of federal income taxes annually over the 20-year period (taking advantage of the 0% and 15% capital gains tax rates with respect to the capital gain portion of the payment). In addition, by spreading the gain over a period of years, he will avoid net investment income taxes altogether.

His associated state income taxes would be about $5,568 annually. This results in a federal income tax (including net investment income tax) and state income tax savings of over $200,000. His savings is due to the tax rules applicable to installment sales which generally provide that each installment payment, which comprises a return of basis, capital gain and interest (with the interest taxed as ordinary income), will be taxable over time when paid to the seller. As a result, Jose was able to manage his annual taxable income and leverage lower tax brackets.