Scenario: Practice Owner Buys a Medical Office

This page describes a composite hypothetical. It is not a real client or a real result, and no real practice is described. All amounts are illustrative assumptions.

The Scenario in Brief

A practice owner wants to buy the medical office building in which the practice operates. The owner is evaluating how to structure the purchase, what depreciation might be available, and whether a cost segregation study would fit. The owner asks an advisor to help organize the questions.

Assumptions Used

• Purchase price: 2,000,000 dollars, with 15 percent, or 300,000 dollars, allocated to land, leaving 1,700,000 dollars of depreciable basis.
• The building is nonresidential, with a 39-year recovery period.
• A hypothetical analysis reclassifies 22 percent of depreciable basis, or 374,000 dollars, into 5, 7, and 15-year categories, including specialized plumbing and electrical, cabinetry, flooring, and parking.
• The building will be held by a separate entity that leases space to the practice.
• The practice is a pass-through entity, and the owner is a working professional with substantial income.

Questions the Advisor Would Ask

The advisor would ask whether the practice's ownership rules permit a separate entity to own the building, whether any partners or associates will share in the property ownership, and whether a lender has requirements. The advisor would also ask how long the owner expects to hold the building and whether a sale of the practice is anticipated, since buyers may wish to lease rather than buy the property. If other professionals will be tenants, rent from them must also be supported.

Worked Arithmetic

A first-year deduction of this size might exceed the property company's income by a wide margin, creating a loss. Whether that loss offsets the owner's professional income depends on the passive activity rules for rentals to a business in which the owner materially participates, on basis and at-risk limits, and on the excess business loss limitation. The advisor would model each step rather than assume the loss is usable.

Interaction with Other Planning

The advisor would also discuss retirement plan design and the qualified business income deduction. Rental income from the property company to the practice could be considered in the qualified business income calculation, and in some cases the treatment of rental income between commonly controlled businesses is relevant. The owner's retirement plan might depend on the practice's compensation rather than the property income, so property ownership and retirement planning are separate considerations.

How It Might Play Out

The owner might decide that a study is worthwhile if the projected loss can be used, and might instead decline if it would only create suspended losses. The owner could also consider a phased approach, purchasing the building first and revisiting the study once the year's income is clearer. The owner should not decide based on the deduction alone: a building purchase ties up capital, adds debt, and can complicate a later sale of the practice.

Risks and Limits

• Rents between related parties should be at market rates and documented.
• Recapture applies to reclassified components on sale.
• Lender and legal requirements may affect the structure.
• The building may reduce liquidity when the owner wants to retire or sell.

What This Scenario Teaches

The scenario shows that owning the building is a separate investment decision from running the practice. Tax planning can support the decision, but it should not drive it. It also shows how many limits sit between a large depreciation number and a usable tax reduction.

Questions to Bring to Your Advisor

1. What is a supportable market rent for my space?
2. How would a study change my first-year taxable income?
3. Can I use a resulting loss, or would it be suspended?
4. How would the building affect a future sale of the practice?

Scenario Variations Worth Considering

Suppose the owner plans to bring in a partner within a few years. The property company might then need to admit the partner or the partner might lease from the owner, which changes the structure and the tax analysis. Suppose instead that the practice is expected to relocate. The building might need to be leased to a new tenant, and the depreciation and recapture picture would look different. Testing these possibilities early helps the owner decide whether the building purchase fits a longer plan, not just the current year.

Recordkeeping Notes for This Scenario

In a real situation like this, the owner would keep the purchase agreement, closing statement, lease, appraisal or assessment supporting the land allocation, and any study report together in a permanent file. The practice would keep evidence that rent is paid on time. Each year, the advisor would review the depreciation schedule and confirm that improvements are being tracked as separate assets. These habits cost little and make later steps, such as a sale or a lender review, much easier.

Educational purposes only. This page is an illustrative educational scenario, not tax, legal, or accounting advice, and it does not describe a real client or a real result. Tax laws change and outcomes depend on individual facts, so consult a qualified professional before acting. No result is guaranteed.