Selling a dental practice to an associate or a younger dentist down the street often comes with a request: can you carry part of the price as a note?
Plenty of sellers say yes, partly because they’ve heard the tax gets spread out too.
The tax part is true… but with conditions.
Selling a dental practice on installment sale can spread a big chunk of your gain over the years you get paid. It can also hand you a tax bill in year one that’s larger than the check you received at closing.
We walk sellers through this math before they sign, because once the purchase agreement is done, most of the tax outcome is already locked in.
That starts with what the IRS actually counts as an installment sale.
What is an Installment Sale When Selling a Dental Practice?
An installment sale is any sale where you receive at least one payment after the tax year the sale happens. That’s the IRS definition in Publication 537, and it comes straight from IRC Section 453.
So if your buyer pays part of the price at closing and the rest on a seller note over five years, you have an installment sale. You don’t have to make an election to get the treatment. The installment method applies automatically unless you choose to elect out.
The idea is fair: you report the gain as the cash shows up.
The catch is that not every dollar of a practice sale qualifies, and the dollars that don’t qualify tend to be the ones taxed at ordinary rates.
Let’s talk about how each payment breaks apart.
Each payment on the note splits into interest, basis, and gain
Every payment you receive on the note is really three things wearing one check.
Per Publication 537, each payment usually consists of: interest income, a return of your adjusted basis, and gain on the sale.
The interest is ordinary income, the same as interest from a bank account.
The return of basis is tax-free, because it’s just your own investment coming back to you.
The gain is the part you report as capital gain or ordinary income depending on what was sold.
How much of each payment counts as gain comes from something called the gross profit percentage. It’s your gross profit on the sale divided by the contract price, and it generally stays the same for every payment you receive.
For most dentists selling a practice they built, there’s a twist. You never paid for the goodwill, so your basis in it is zero. That means nearly every dollar of principal tied to goodwill is gain.
Selling costs trim it slightly, but you’re deferring almost pure gain, not a small slice of it.
Your Purchase Price Allocation Decides How Much You Can Actually Defer
The allocation in your purchase agreement decides which part of the price is deferrable and which part hits this year.
We like to describe buying a practice as a Costco run with an itemized receipt: equipment, supplies, patient records, goodwill, non-compete, each with its own line.
When you’re the seller, that same receipt drives your tax bill.
The IRS doesn’t treat a practice sale as one asset. Publication 537 says you allocate the price and the payments across each class of asset, and each class follows its own rules:
- Goodwill and patient base you built: eligible for installment reporting, generally capital gain.
- Equipment and cabinetry you depreciated: depreciation recapture, up to your gain, is ordinary income in the year of sale. Leasehold improvements follow different recapture rules.
- Inventory: can’t use the installment method at all.
Buyers want more of the price on equipment, because they can write it off faster. Sellers want more on goodwill.
The written allocation is binding on both of you unless the IRS decides the amounts aren’t appropriate, and both sides report it on Form 8594.
We see this constantly in doc-to-doc deals: the allocation gets settled in five minutes near the end, and nobody on the selling side asked what it does to year one.
That leads to the biggest year-one surprise, which is where we turn next.
Equipment Recapture is Due in the Year of Sale, Note or No Note
Depreciation recapture is taxed in the year you sell, whether or not you received a payment that year.
That’s the one rule that trips up more installment sellers than any other, and the IRS is blunt about it in Publication 537.
Here’s why it exists.
Over the years, you wrote off your chairs, imaging, sterilization equipment, and buildout. When you sell those assets for more than their written-down value, the IRS takes back that benefit as ordinary income. Publication 544 explains that this applies to property that was subject to depreciation or amortization, and only the gain above the recapture amount goes on the installment method.
That amortization piece matters if you bought your practice from someone else. Goodwill you purchased was amortized over 15 years, so part of your goodwill gain can be recaptured too, not just the equipment.
Let’s look at the numbers on a typical deal.
A Seller Note Example Shows The Year-One Cash Trap
Let’s look at an example built on a pattern we see all the time when a seller carries paper.
The numbers are rounded to keep the math readable.
- A dentist sells a practice they built from scratch for $900,000.
- The agreement puts $150,000 on equipment that’s been fully written off and the rest on goodwill.
- The buyer pays $100,000 at closing and signs a note for the balance, paid over five years with interest.
In the year of sale, the full $150,000 of equipment recapture is reportable as ordinary income, even though only $100,000 of cash has arrived.
The gain on the goodwill portion of the down payment is reportable too. That’s what we mean by the year-one cash trap: the tax on the recapture can be due before the note has paid you much of anything.
In each later year of the note, the part of each principal payment tied to goodwill is reported as gain, and the interest is ordinary income. That’s the spreading you were promised.
The sellers who get caught by this usually aren’t careless. They just never saw year one laid out before the down payment was negotiated, and sizing that down payment to cover the year-one tax is often the simplest fix.
How Do You Report An Installment Sale to the IRS?
You report an installment sale on Form 6252, and you file it for the year of sale and for every year of the installment agreement, even a year when no payment arrives. (The IRS page for Form 6252 covers the current version and instructions.)
Recapture is figured on Form 4797 and reported as ordinary income in the year of sale. The allocation between goodwill and other assets goes on Form 8594, which both you and the buyer attach to your returns for the year of sale. If your Form 8594 and the buyer’s don’t match, that’s a conversation neither of you wants with the IRS.
You can also elect out of the installment method and report the entire gain in the year of sale.
Some sellers do that on purpose, for example, when they have losses to absorb the gain that year. It’s a real choice, and once made, it can only be revoked with IRS approval. There are also a few things that can pull deferred income forward.
A Few Rules Can Pull Future Income Into This Year
The installment method has guardrails, and a handful of them can accelerate income you thought was deferred.
These are the ones that come up in dental practice sales:
- Borrowing against the note. If you pledge the note as security for a loan and the selling price is over $150,000, the loan proceeds can be treated as a payment on the note, per Publication 537.
- Selling to a related buyer. If the buyer is a related person and resells within 2 years, the resale price can be treated as received by you, under IRC Section 453(e).
- Very large notes. Once a sale is over $150,000 and your outstanding installment balances top $5 million at year-end, you owe interest on the deferred tax, per Publication 537. Most solo practice sales won’t reach that, but multi-location owners should check.
- Too little interest. If the note doesn’t carry enough stated interest compared to the applicable federal rate, the IRS can recharacterize part of your principal as interest, which is ordinary income.
None of these are reasons to avoid seller financing, just reasons to draft the note with the tax side in the room.
Is Spreading The Tax Worth Carrying The Buyer’s Note?
Spreading the tax is worth it when the deferral is meaningful, and you trust the buyer to pay. An installment sale defers tax. It doesn’t erase it, and it swaps a tax problem for a credit problem.
If the buyer struggles, you’re a lender to a practice you no longer run. That’s why sellers usually want a solid down payment, a personal guarantee, and security in the practice assets.
Your practice valuation matters here too, because a note sized off an inflated price is a note the buyer may not be able to carry. Our dental practice valuation calculator is a sensible gut check before you agree to finance anything.
We say this about practice numbers all the time: catch it at the cavity stage, not the extraction stage.
The time to shape an installment sale is before the letter of intent, when the allocation, the down payment, and the interest rate are all still on the table. That’s the kind of exit work our dental tax strategy services are built for, alongside the rest of your steps to sell your dental practice.
If you’re thinking about carrying a note on your practice sale, book a call with our team, and we’ll run your numbers on your deal before you sign.
If you liked this, you might also like: Tax Consequences of Selling a Dental Practice
Until next week.
About the Author
Omar Virjee, CPA is the founder of Virjee Consulting, a CPA firm specializing in year-round tax planning and monthly bookkeeping for solo and small-group dental practice owners across the United States. Omar focuses on helping dentists maximize owner take-home pay through proactive tax strategy, S-Corp optimization, dental real estate planning, and clear monthly financials.
Meet Omar · Schedule a Consultation
Getting owner pay right is half tax question and half payroll mechanics, and our dental payroll services cover the mechanics side.
