When selling a veterinary practice, many owners focus on the big-ticket items like equipment value, goodwill, and real estate. However, a critical but often overlooked component of the sale is the treatment of “hot assets” — a category of assets that can significantly affect your tax liability.
What Are Hot Assets?
In the context of the Internal Revenue Code (IRC §751), “hot assets” refer to certain types of property that generate ordinary income when sold, rather than the more favorable capital gains treatment. In a veterinary practice, common hot assets may include:
• Accounts receivable (if not a cash-basis taxpayer)
• Inventory and supplies
• Depreciation recapture from equipment or leasehold improvements
These assets are termed “hot” because they trigger ordinary income tax rates, which are often higher than long-term capital gains rates — potentially leading to a larger tax bill upon sale.
How Hot Assets Affect a Practice Sale
In most veterinary practice sales, the transaction is structured as an asset sale, particularly if the practice is operated as a sole proprietorship, partnership, or LLC. In an asset sale, each asset is individually valued and assigned a portion of the total purchase price. The IRS requires that both buyer and seller report these values using IRS Form 8594.
The way the sale price is allocated among assets, including hot assets, directly affects the seller’s tax outcome:
• Hot assets are taxed at ordinary income rates, currently as high as 37% at the federal level.
• Non-hot assets, such as goodwill and real estate held over a year, are usually taxed at the capital gains rate, typically 15–20%.
As an example, if $200,000 of the sale price is allocated to fully depreciated equipment, that amount will be taxed as ordinary income to the seller, rather than at the lower capital gains rate.
Planning Ahead to Minimize Taxes
Understanding and planning for hot asset treatment can save a seller thousands in unnecessary taxes. Here are some best practices:
1. Negotiate Asset Allocation Wisely: While buyers may prefer to allocate more to equipment (for faster depreciation), sellers should push for allocations that minimize exposure to hot asset taxation — such as greater weight on goodwill.
2. Work with a Tax Advisor Early: Before even listing the practice for sale, consult with a CPA or tax attorney familiar with veterinary practice sales. They can help forecast tax liabilities and structure the deal accordingly.
3. Review Depreciation Schedules: Depreciation recapture can sneak up on sellers. Ensure all fixed assets are correctly accounted for and updated.
Equity
In rare cases where a sale of equity is possible (e.g., for a C-corp), it is important to be mindful of the Accounts Receivable in the transaction. If the seller is an MSO, which provides non-clinical and business support services to a veterinary practice, the MSO may carry large receivables from the Veterinary Practice. Proactive management of the Accounts Receivables is critical to avoiding a large tax bill in the future.
Final Thoughts
Hot assets can be a hidden trap in veterinary practice sales, quietly inflating your tax bill if not handled properly. By understanding their implications and working with knowledgeable advisors, you can structure your sale to preserve more of your hard-earned value — and avoid surprises come tax time. The National Veterinary Law Group at Mandelbaum Barrett PC is here to help. Contact us today.