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Buying a pharmacy? Here's what you need to know about depreciation and amortization.
Buying a pharmacy is one of the bigger financial decisions you will make in your lifetime. Whether you are buying assets or the common stock, it is imperative that you understand any opportunities you may have to maximize the post-closing cash flow from the purchase.
Generally, there are two ways to purchase a pharmacy:
Depreciation and Amortization Benefits
Depreciation is the expensing of tangible assets, such as equipment and furniture, over a period of time. Amortization is the expensing of intangible assets, such as goodwill/script value, over a period of time. There is no actual cash outlay for the pharmacy for depreciation and amortization; it’s simply a tax adjustment on the books to help a taxpayer deduct acquisition costs and ultimately lower taxable income.
Related article: Buying Multiple Independent Pharmacies Can Make Sense
When buying the stock of a pharmacy, the taxpayer is not allowed any depreciation for the price paid for the stock. Generally, the purchase price of the stock can only be deducted for tax purposes when the stock is eventually sold, which can be a very long time for a new pharmacy owner. However, when buying specific assets, you can depreciate or amortize the assets you purchased.
For example, if you purchased furniture and fixtures for $50,000 and a robot for $100,000, the government allows you to generally expense that over a five- or seven-year period. However, there are also special bonus depreciation rules that may allow you to deduct the entire amount in the first year. Goodwill or script value, an intangible asset, is amortized or expensed over 15 years.
Value of Asset Purchases
Clearly, being able to deduct the cost of the assets you purchased is a major cash and tax planning opportunity. First, a buyer will want to allocate as much of the purchase price to the furniture, fixtures, and equipment so they can recover their cost quicker. Keep in mind, however, that a seller will want to allocate as little as possible to the furniture, fixtures, and equipment because it will most likely cause the seller to report ordinary income, which is taxed at the higher ordinary tax rates.
Secondly, the expensing of furniture, fixtures, and equipment can be accelerated by using special tax elections under Section 179 and/or Section 168(k). These elections allow taxpayers to potentially expense or depreciate the entire cost of the asset in one year instead of five or seven years. As a new pharmacy owner, utilizing depreciation to lower or even eliminate any tax liabilities in your startup years is a major benefit. Furthermore, these elections could be used as a broader tax plan to create losses, which can be utilized to offset other income. Anyone thinking of buying the stock of a pharmacy should make sure they understand the depreciation benefits they may be giving up.
Consider Tax Exceptions
As with most tax laws, there are exceptions. A stock purchase may be eligible to be structured under IRC Section 336(e) or 338(h)(10). With these elections, you can purchase the common stock of a pharmacy but still receive the depreciation benefits of an asset purchase. This is very valuable in areas where licensing and other set-up requirements for new pharmacies are onerous. Before you consider these elections, you should work with a competent healthcare and transactional attorney as well as a CPA with experience in these elections. The requirements of such transactions are specialized, and both parties must agree to them.
Taking time to understand your options in regards to depreciation and amortization when buying a pharmacy can help you increase cash flow, lower your tax liability, and negotiate the right purchase price.