Navigating Capital Gains Tax Changes as Physicians

For physicians who own their medical office buildings, proposed changes to capital gains tax rates represent one of the most significant financial considerations when planning a property sale. Understanding these changes and implementing strategic responses can potentially save hundreds of thousands—or even millions—of dollars in tax liability.

The landscape of capital gains taxation is shifting, and physician-owners need to understand both the current proposals and the strategic options available to minimize tax impact when selling medical real estate.

Understanding the Proposed Changes

Current Capital Gains Tax Framework

Under current law, long-term capital gains (assets held longer than one year) are taxed at preferential rates compared to ordinary income:

• 0% rate: For taxpayers in the 10-12% ordinary income tax brackets
• 15% rate: For most middle and upper-middle income taxpayers
• 20% rate: For high-income taxpayers (single filers over $492,300; married filing jointly over $553,850 in 2024)
• Net Investment Income Tax (NIIT): Additional 3.8% Medicare surtax on investment income for high earners

Most physician-owners selling medical properties currently face the maximum federal capital gains rate of 23.8% (20% base rate plus 3.8% NIIT), plus applicable state taxes.

Proposed Tax Changes

Recent budget proposals have included provisions that would significantly increase capital gains taxes for high-income taxpayers:

Maximum Rate Increase to 44.6%: For taxpayers earning over $1 million annually, the proposal would tax long-term capital gains as ordinary income at the top marginal rate (39.6%), plus the 3.8% NIIT, plus a new 1.2% Medicare tax on high earners.

Implementation Timing: If enacted, changes could take effect retroactively to the beginning of the tax year or prospectively from the enactment date.

State Tax Implications: Combined with state income taxes (which range from 0% in states like Texas and Florida to over 13% in California), total capital gains rates could exceed 55-60% for some physicians.

Who Would Be Most Affected?

The proposed changes would primarily impact physicians in the following situations:

High-Income Specialty Practices

Physicians in high-earning specialties (orthopedics, cardiology, gastroenterology, radiology, anesthesiology) who regularly exceed $1 million in annual income would face the highest rates.

Large Property Sales

Physicians selling medical buildings with significant appreciated value—particularly properties purchased decades ago at much lower basis—would see substantial tax increases. For example:

• Property purchased in 2000 for $2 million
• Current market value: $8 million
• Taxable gain: $6 million
• Tax at 23.8% (current): $1,428,000
• Tax at 44.6% (proposed): $2,676,000
• Additional tax liability: $1,248,000

Practice Sale Combined with Property Sale

Physicians selling both their practice and medical real estate in the same year could easily exceed the $1 million income threshold, triggering the higher rates on both transactions.

Strategic Response Options

Regardless of whether proposed tax increases are enacted, physicians should consider several strategic approaches to minimize capital gains tax liability:

1. Accelerated Sale Timing

The Strategy: Complete property sales before any tax increases take effect.

Advantages:

• Lock in current lower tax rates
• Eliminate uncertainty about future tax policy
• Gain immediate liquidity and eliminate property management responsibilities

Considerations:

• May require accepting current market pricing rather than waiting for optimal conditions
• Transaction timelines can be 90-120 days; act early to ensure closing before potential effective dates
• Could create temporary cash flow challenges if practice operations remain in the building

2. 1031 Tax-Deferred Exchange

The Strategy: Use IRC Section 1031 to defer capital gains taxes by exchanging into like-kind replacement property.

How It Works:

• Sell medical office building
• Identify replacement property within 45 days
• Close on replacement property within 180 days
• Defer all capital gains taxes until eventual sale of replacement property

Suitable Replacement Properties:

• Different medical office buildings (reduce management if desired)
• Net-leased medical properties (passive income)
• Healthcare real estate investment portfolios
• Diversified commercial real estate

Key Advantage: 1031 exchanges remain effective regardless of capital gains tax rates—deferring a 44.6% tax is even more valuable than deferring a 23.8% tax.

3. UPREIT Transaction Structure

The Strategy: Contribute medical property to a real estate investment trust (REIT) in exchange for operating partnership units, deferring capital gains indefinitely.

How It Works:

• Property is contributed to a REIT's operating partnership
• Physician receives OP units equal to property value
• Units generate quarterly distributions similar to dividends
• No capital gains tax until units are sold
• Units can be held until death, providing step-up in basis for heirs

Benefits:

• Complete tax deferral without replacement property requirements
• Professional management of real estate portfolio
• Liquidity through quarterly distributions
• Portfolio diversification across multiple properties
• Estate planning benefits through basis step-up

4. Installment Sale

The Strategy: Structure the sale to receive payments over multiple years, spreading capital gains tax liability across multiple tax years.

Advantages:

• Avoid single-year income spike that might trigger higher rates
• Stay below $1 million income threshold in any given year
• Receive interest on deferred payments
• Maintain some ongoing involvement or control during transition period

Risks:

• Buyer credit risk over extended payment period
• If tax rates increase, future installments could be taxed at higher rates
• Delayed liquidity compared to all-cash sale

5. Charitable Remainder Trust

The Strategy: Donate property to a charitable remainder trust (CRT), which sells the property tax-free and provides income stream to donor.

How It Works:

• Transfer property to CRT before sale
• CRT sells property without paying capital gains tax
• CRT pays income to donor (typically 5-7% annually) for specified period or lifetime
• Remaining assets pass to designated charity at end of term
• Donor receives immediate charitable deduction

Best For: Physicians with charitable intent who don't need full sale proceeds immediately and want to support causes they care about while reducing taxes.

6. Opportunity Zone Investment

The Strategy: Invest capital gains into Qualified Opportunity Zone (QOZ) funds within 180 days of sale to defer and reduce capital gains taxes.

Benefits:

• Defer capital gains until 2026 or until QOZ investment is sold
• If held 10+ years, eliminate all capital gains on appreciation of QOZ investment
• Support economic development in designated areas

Considerations: Requires investment in specific geographic zones and asset types; carry investment risk associated with QOZ project.

Partial Sale Strategies

For physicians not ready to exit completely, partial ownership sales can provide liquidity while managing tax exposure:

Sell Minority Interest

Sell 49-60% ownership stake to institutional buyer while retaining partial ownership and control. This strategy:

• Generates substantial liquidity without full exit
• Spreads capital gains across smaller initial sale
• Allows physician to participate in future appreciation
• Provides professional management partner

Staged Sale Over Multiple Years

Structure transactions to sell portions of the property in different tax years, managing income threshold exposure.

State Tax Considerations

State income tax adds another layer of complexity:

High-Tax States: Physicians in California (13.3%), New York (10.9%), New Jersey (10.75%), and other high-tax states face combined federal and state rates potentially exceeding 55-60% under proposed changes.

No State Income Tax States: Physicians in Texas, Florida, Nevada, Washington, Tennessee, South Dakota, Wyoming, Alaska, and New Hampshire benefit from zero state capital gains tax.

Relocation Strategy: Some physicians consider establishing primary residence in no-tax states before selling to avoid state capital gains tax entirely. However, this requires genuine change of domicile with significant documentation and typically 12+ months of residency.

Depreciation Recapture

Don't forget about depreciation recapture—even with proposed capital gains changes, depreciation recapture on commercial property remains taxed at 25%:

• Total depreciation taken over ownership period is "recaptured"
• Taxed at 25% regardless of capital gains rates
• Cannot be avoided through 1031 exchange (deferred but not eliminated)
• UPREIT structures can defer depreciation recapture along with capital gains

Action Steps for Physician-Owners

Given the uncertainty surrounding tax policy changes, physicians who own medical real estate should take the following steps:

1. Conduct Tax Impact Analysis

Work with CPAs to model tax liability under various scenarios:

• Current tax rates
• Proposed higher rates
• Different sale structures (outright sale, 1031, UPREIT, installment, etc.)
• State tax implications

2. Obtain Property Valuation

Understand current market value to calculate potential tax liability and evaluate timing decisions.

3. Review Estate Planning

For physicians approaching retirement or with significant estates, coordinate property sale strategies with overall estate plan. Consider:

• Holding property until death for basis step-up (eliminates capital gains for heirs)
• Gifting strategies to shift income to lower-bracket family members
• Trust structures that provide income while reducing estate taxes

4. Assess Liquidity Needs and Timeline

Determine whether immediate liquidity is needed or whether tax-deferral strategies make sense:

• Retirement funding needs
• Practice transition plans
• Other investment opportunities
• Risk tolerance for continued real estate ownership

5. Engage Specialized Advisors

Capital gains tax planning for medical real estate sales requires coordination among:

• CPAs with healthcare real estate tax expertise
• Healthcare real estate advisors who understand transaction structures
• Estate planning attorneys
• Financial advisors for post-sale wealth management

The Window May Be Closing

Whether or not capital gains tax increases are ultimately enacted, the current environment creates urgency for physician property owners to evaluate their options.

Key considerations:

• Legislative Uncertainty: Tax policy can change with election cycles and shifting Congressional priorities
• Retroactive Provisions: Some tax changes take effect retroactively from the beginning of the year, leaving little time to react
• Market Timing: Beyond taxes, 2025 may present favorable market conditions with improving financing and strong buyer demand
• Personal Factors: Age, health, practice transition plans, and family considerations may make current timing optimal regardless of tax policy

Conclusion: Proactive Planning Is Essential

Proposed capital gains tax increases represent a significant financial consideration for physicians who own medical real estate. However, physicians have multiple strategic tools available to minimize tax impact—if they plan proactively.

The worst approach is inaction driven by uncertainty. Whether rates increase or remain stable, implementing tax-efficient sale structures and timing decisions strategically can save substantial sums.

For many physician-owners, 2025 represents a unique opportunity: improving real estate market conditions combined with potential tax increases create compelling reasons to act now rather than wait.

The key is working with experienced advisors who understand both healthcare real estate markets and sophisticated tax planning strategies to develop a customized approach aligned with your financial goals, practice timeline, and estate planning objectives.