The Real Cost to Acquire a Dental Practice

By: Bruce Bryen

The dental school graduate is ready to acquire a dental practice and wants to understand how much it really costs:

You have been a dental school graduate for the last five years and have been working as an associate in someone’s dental practice. The clinical skills you have learned have gotten you to the point where you are ready to acquire a small dental practice of your own. You have also mastered a lot of non-clinical administrative skills so that you are sure you are ready to buy a practice

You are also at a point where you want to hire a dental CPA to assist you in this endeavor since you know that he or she is the right person to help with understanding the profit potential of the practice you seek to purchase. You think you found the right office so the dental CPA begins his or her work to advise you on what price to offer for the practice.  You are advised not to worry about the listing price of the practice because the dental CPA will prepare an evaluation of the practice to give you a “true,” value, and the price he or she will advise you of the offer to purchase that you should present. 

Is the dental CPA at the top of his or her game or do you need a credentialed CVA to make sure that you have gotten the real price of the acquisition?

What does the real price mean if the buyer and seller have agreed upon the transition price being $500,000?  The listed price of the practice may have been $550,000. Aren’t you as the buyer paying $500,000 and the seller accepting $500,000? This is where the CPA/CVA earns money.  Many tax considerations affect what the price really is.  Do you get to write off part of or most of the purchase price on your tax return?  Does the seller report a capital gain and pay the least amount of tax possible?  Does he or she report some or a lot of ordinary income and pay a higher tax?  Your CPA/CVA will or should tell you that the more the seller reports as capital gains, the more you will pay in tax. 

As an opposite approach, the more the seller reports as ordinary income, the more he or she pays in tax and the less you pay. This tax is part of the additional cost to acquire a practice that is above the $500,000 transition price.  As a buyer, you have to understand this concept because the additional “price,” in tax dollars is a real price and should be added to the cost of the practice for your understanding. The explanation is also providing the proper amount of financing to acquire the practice and to have the needed working capital. This is so the practice can afford to wait as the insurance collections arrive or the regular accounts receivable is collected.

An explanation of the way the taxes appear for the buyer and the seller:

Many think that the taxes to be paid come from the seller only because he or she is the one who is receiving the money for the transition so he or she must be the one who is paying the tax.  That is not true.  An outline of the buyer and his or her tax will be explained in this paragraph.  The best example may be to use a person’s home mortgage as a guide to understanding the tax implications of the buyer.  In a typical transition, the buyer makes an application to a lender to borrow the $500,000 needed for the acquisition.  There should be a working capital component that the borrower needs that is also borrowed from the lender so that there is enough cash in the account to pay all the bills while waiting for collections to be provided.  If you think about making a mortgage payment, the interest is deductible for the most part on your tax return but the principal payment is not.  Because on a long-term mortgage almost all of the payment goes to interest for quite a few years, most people don’t pay attention to the small part of the payment that amortizes the loan. 

There are only two ways that the principal can be paid. One way is by refinancing the loan and paying down the balance with a new loan.  This is not taxable. The other way is to report enough income to pay down the balance.  Since income must be reported to get the funds to pay the balance, there is a tax on that amount.  So in essence, the loan is being paid and then the funds to pay the loan which come from income are taxed. This means that the money used to pay the loan is subject to a tax. The tax is based on the taxpayer’s individual rate.

Let’s be specific:

Since you can’t get a long-term loan for the acquisition of a dental practice like for example, a twenty-five-year mortgage loan for a house, you will feel the sting of the principal payment immediately.  Using the $500,000 transition price as the loan amount, which is a normal approach, and receiving a seven to ten-year loan from the bank for the purchase of the practice, you would be paying $50,000 per year in principle, based on a level ten-year amortization. Where does that $50,000 come from to make the loan payment?  If it comes from earning $50,000, you then are subject to tax on that amount. 

Remember that with a mortgage payment on a house, you will probably be paying approximately $100 give or take, in principal payments per month.  On the $50,000 payment, with federal, state, and double social security taxes since you are the owner, your tax rate will be about 50% so to pay $50,000 against a loan balance, you will need another $50,000 to pay the tax on $50,000 loan payment. The dental CPA may save you some money but you can’t escape the large tax on the principal payments that will have come from your income.

Photo by Karolina Grabowska

Up Next: How Dental Students Can Save for Their Own Practice

Bruce Bryen

Bruce Bryen

Bruce Bryen, CPA/CVA Dental Practice Valuation Analyst, Baratz & Associates, PA