Key Considerations - Succession Planning

For physicians who own their medical office buildings, succession planning involves navigating two complex transitions simultaneously: exiting the practice and disposing of valuable real estate. Unlike physicians who simply retire from leased spaces, property-owning physicians must coordinate practice transitions with real estate strategy to maximize value, minimize taxes, and ensure smooth handoffs.

Proper succession planning requires years of advance preparation and coordination among multiple advisors. Physicians who begin planning 5-10 years before intended retirement consistently achieve better outcomes than those who wait until the exit is imminent.

The Unique Challenge of Dual Ownership

Owning both your practice and the real estate creates several planning complexities:

Timing Coordination

Practice and property don't necessarily need to be sold simultaneously—but the sequence and timing significantly impact value and tax consequences:

• Property Before Practice: Reduces practice value (buyer must lease vs. own)
• Practice Before Property: May leave you owning building with tenant you didn't select
• Simultaneous Sale: Maximizes value but requires complex coordination

Buyer Alignment

Practice buyers and real estate buyers are often different entities with different interests:

• Practice Buyers: Younger physicians, PE-backed groups, hospital systems—want to acquire patient relationships and revenue streams
• Property Buyers: REITs, private equity real estate funds, institutional investors—want stable, long-term cash flow from real estate

Aligning these two buyer groups requires strategic structuring.

Tax Complexity

Selling practice and property in the same year can create significant tax consequences:

• Practice sale generates ordinary income (goodwill may qualify for capital gains treatment)
• Property sale generates capital gains and depreciation recapture
• Combined income may push you into highest tax brackets and trigger alternative minimum tax
• Tax-deferred structures (1031 exchanges, UPREITs) may be essential

Key Planning Considerations

1. Timeline Determination

When Do You Want to Exit?

Establishing a target retirement timeline drives all other planning decisions:

• 5-10 Years Out: Ideal planning horizon—time to optimize property condition, renew leases, groom successors, and structure tax-efficient transactions
• 3-5 Years Out: Sufficient time for planning but requires more focused action on property preparation and successor identification
• Under 3 Years: Limited time creates constraints; may need to compromise on timing or accept less optimal structures

Flexibility Considerations:

• Can you work part-time during transition?
• Are you willing to stay on temporarily if buyer requests transition assistance?
• Could health or personal circumstances force earlier exit?

2. Practice Transition Strategy

Your practice succession approach directly impacts real estate strategy:

Internal Succession (Junior Partners Buying)

Structure: Younger partners or associates purchase your practice ownership over time.

Property Implications:

• Property Sale to Third Party: Sell building to institutional investor, practice leases back. This provides liquidity while internal successors acquire practice without capital-intensive real estate purchase
• Property Sale to Successors: Seller-financed sale of building to junior partners over time. Provides ongoing cash flow but ties up capital
• Retain Ownership: Keep property, lease to successor-controlled practice. Generates passive income but maintains management burden

External Sale (Selling to Hospital or PE Group)

Structure: Hospital system, private equity-backed group, or other external party acquires practice.

Property Implications:

• Bundled Transaction: Some buyers (especially hospitals) may want to acquire both practice and real estate. Often results in below-market property pricing
• Separate Transactions: Sell property to real estate investor, practice to healthcare operator. Maximizes property value through competitive process
• Sale-Leaseback: Sell property to institutional investor before practice sale, creating clean leaseback arrangement for practice buyer

Wind-Down Without Sale

Structure: Gradually reduce practice hours and patient load, eventually closing practice.

Property Implications:

• Property becomes vacant, requiring tenant backfill or sale
• Often the least economically favorable option
• Consider selling property while practice is operating to maintain value

3. Property Timing: When to Sell Real Estate

The optimal timing for property sale depends on multiple factors:

Option A: Sell Property Before Practice Exit

Timing: 2-5 years before practice transition

Advantages:

• Provides liquidity for retirement planning and diversification
• Eliminates property management burden during practice transition
• Sale-leaseback allows continued practice in familiar location
• Property sale and practice sale in different tax years spreads income
• Makes practice more attractive to buyers (no real estate to negotiate)

Disadvantages:

• Reduces practice value—practice buyers value owned real estate
• Commits to lease terms that may not align with practice sale timeline
• Potential capital gains tax unless structured as 1031 or UPREIT

Best For: Physicians wanting liquidity and simplification before practice transition; those with 3-5+ years until exit.

Option B: Sell Property Simultaneously with Practice

Timing: At point of retirement or practice exit

Advantages:

• Maximizes total transaction value (property and practice together worth more than separately)
• Clean break—no ongoing obligations after retirement
• Can structure as bundled deal or separate synchronized transactions

Disadvantages:

• Significant tax hit from combined income in single year
• Complex coordination requiring expert advisors
• Adds complexity to practice sale negotiations
• If either sale falls through, may derail both transactions

Best For: Physicians wanting complete exit; those with strong tax planning (1031 exchanges, UPREITs, installment sales).

Option C: Sell Practice, Retain Property

Timing: Sell practice first, hold property for ongoing income

Advantages:

• Generates passive rental income in retirement
• Benefit from future property appreciation
• Estate planning benefits—property can pass to heirs with step-up in basis
• Spreads income recognition across multiple years

Disadvantages:

• Continued property management responsibility
• Tenant risk—new practice owner may fail or vacate
• Capital expenditure obligations (roof, HVAC, parking lot, etc.)
• Illiquid asset—difficult to access capital if needed

Best For: Physicians wanting passive income; those with estate planning motivations; younger retirees (early 60s) who can manage property for years.

4. Tax Planning Strategy

Minimizing tax liability is critical for succession planning:

1031 Exchange

Defer capital gains by exchanging medical property for other investment real estate:

• Mechanism: Sell property, identify replacement property within 45 days, close within 180 days
• Benefits: Defer 100% of capital gains taxes
• Replacement Options: Different medical office, net-leased properties, multifamily, diversified real estate portfolios
• Considerations: Must reinvest all proceeds; assumes you want continued real estate ownership

UPREIT Transaction

Contribute property to REIT operating partnership, receive units, defer taxes indefinitely:

• Benefits: Tax deferral without replacement property requirements, professional management, liquidity through quarterly distributions
• Ideal For: Physicians wanting real estate exposure without management burden

Installment Sale

Receive property sale proceeds over multiple years, spreading tax liability:

• Structure: Buyer pays over 3-10 years, seller recognizes gain as payments received
• Benefits: Spreads tax liability, generates ongoing income, can stay below certain income thresholds
• Risks: Buyer credit risk, if rates increase future payments taxed at higher rates

Charitable Remainder Trust

Donate property to CRT, which sells tax-free and provides income for life:

• Benefits: Avoid capital gains tax, receive lifetime income, support charitable causes, immediate charitable deduction
• Best For: Physicians with charitable intent who don't need full proceeds immediately

5. Property Preparation and Value Optimization

Years before sale, take steps to maximize property value:

Lease Management

• Extend or Renew Leases: Properties with long remaining lease terms command premium pricing. Renew leases 2-3 years before planned sale
• Eliminate Month-to-Month Tenants: Convert to long-term leases or replace with committed tenants
• Document Below-Market Rents: If rents are below market, document this—buyers will underwrite to market rates, supporting higher valuations

Property Condition

• Address Deferred Maintenance: Fix roof issues, HVAC problems, parking lot defects—buyers will discount heavily for deferred maintenance
• Cosmetic Improvements: Fresh paint, updated landscaping, modern signage create positive first impressions
• Capital Planning: If major capital items (roof, HVAC) are nearing end of life, consider replacement 2-3 years before sale

Financial Documentation

• Clean Financial Records: Organize 3+ years of operating statements, tax returns, rent rolls
• Separate Personal Expenses: Eliminate personal expenses run through property to show true NOI
• Document Triple-Net Structure: If you pay building expenses, document that market leases would be NNN, increasing apparent NOI

6. Liquidity and Cash Flow Planning

Understand how succession decisions impact retirement cash flow:

Lump Sum Liquidity

Property sale provides immediate cash:

• Typical $5-10 million medical property generates $3-7 million net proceeds after loan payoff
• Allows debt payoff, investment portfolio diversification, major purchases
• Eliminates ongoing property management responsibility

Ongoing Income Stream

Retaining property or using installment sale provides continuing cash flow:

• Rental income typically 6-8% of property value annually
• More tax-efficient than taking lump sum in high-income year
• Continues until property eventually sold or passes to heirs

Practice Sale Proceeds

Don't forget practice sale provides separate liquidity:

• Typical practice goodwill: 40-70% of annual collections
• For $3 million/year practice, goodwill might be $1.2-2.1 million
• Combined with property sale, provides substantial retirement funding

7. Family and Estate Planning Integration

Succession planning should coordinate with broader estate planning:

Basis Step-Up Strategy

Holding property until death provides heirs with step-up in basis, eliminating capital gains:

• Example: Property worth $8M, basis $2M, built-in gain $6M
• If held until death, heirs receive property at $8M basis, no capital gains tax
• Savings: $1.4 million+ in avoided capital gains tax

Best for physicians in good health with substantial other retirement assets.

Gifting Strategies

Consider gifting property interests to children or trusts:

• Annual exclusion gifts ($18,000 per recipient in 2024)
• Valuation discounts for minority interests (25-35% discounts possible)
• Removes appreciation from taxable estate

Trust Structures

• QPRT (Qualified Personal Residence Trust): Transfer property to trust, retain income for specified period, property passes to beneficiaries
• FLP (Family Limited Partnership): Hold property in partnership, gift limited partnership interests to children at discounted valuations
• Charitable Trusts: As discussed above, CRTs provide income and charitable benefits

Common Succession Planning Mistakes

1. Starting Too Late

Physicians who begin planning 1-2 years before retirement have limited options and often accept suboptimal outcomes. Begin 5-10 years out for maximum flexibility.

2. Ignoring Tax Consequences

Selling practice and property in the same year without tax planning can result in 40-50%+ effective tax rates. Proper structuring can save hundreds of thousands.

3. Failing to Prepare Property

Properties with deferred maintenance, short lease terms, or poor documentation sell at significant discounts. Invest in preparation 2-3 years before planned sale.

4. Accepting Bundled Offers Without Competition

Hospital systems or PE groups often offer to buy both practice and property together—typically at below-market real estate pricing. Always test real estate value through competitive process.

5. Not Coordinating Advisors

Succession planning requires coordinated advice from CPAs, attorneys, financial advisors, and healthcare real estate specialists. Siloed planning leads to missed opportunities and costly mistakes.

The Advisory Team You Need

Successful succession planning requires multiple specialized advisors:

• Healthcare Real Estate Advisor: Values property, identifies buyers, structures transactions, maximizes proceeds
• CPA with Healthcare Expertise: Models tax scenarios, structures transactions for tax efficiency, coordinates 1031 exchanges
• Estate Planning Attorney: Drafts trusts, advises on gifting strategies, coordinates estate plan with succession plan
• Practice Transition Consultant: Values practice, identifies practice buyers, structures practice sale
• Financial Advisor: Models retirement cash flow needs, advises on asset allocation post-sale, coordinates overall financial plan

These advisors should meet collaboratively to ensure coordinated strategy.

Action Plan: 10 Years to Retirement

10 Years Out:

• Establish target retirement date
• Obtain preliminary property valuation
• Begin estate planning discussions
• Consider grooming internal successors

7 Years Out:

• Engage succession planning advisory team
• Model financial scenarios for different timing approaches
• Address deferred property maintenance
• Optimize lease structure

5 Years Out:

• Finalize succession strategy (practice and property timing)
• Begin detailed tax planning (1031, UPREIT, charitable trusts)
• Complete major capital improvements if needed
• Consider sale-leaseback if pursuing that strategy

3 Years Out:

• Renew or extend tenant leases
• Engage healthcare real estate advisor for property marketing plan
• Begin practice transition discussions with potential buyers
• Finalize tax-deferral structure

1-2 Years Out:

• Execute property sale or sale-leaseback
• Finalize practice sale agreement
• Complete transition to successors
• Implement retirement and estate plan

Conclusion: Plan Early, Execute Strategically

Succession planning for physicians who own medical real estate is complex but manageable with proper advance planning and expert guidance. The physicians who achieve the best outcomes start planning 5-10 years before retirement, coordinate practice and property strategies, implement tax-efficient structures, and work with specialized advisors.

The stakes are significant—the difference between well-executed and poorly-executed succession planning can easily amount to $500,000-$1 million+ in value preservation through optimal timing, tax planning, and transaction structuring.

Most importantly, proper succession planning provides peace of mind. Rather than scrambling to address practice transition and property disposition under time pressure, physicians who plan strategically can transition on their terms, at their timeline, with confidence that they've maximized value and minimized taxes.

If you're within 10 years of planned retirement and own your medical office building, now is the time to begin succession planning. The earlier you start, the more options you'll have and the better your outcomes will be.