Selling a practice or business: optimising the tax and reinvesting the proceeds sensibly

Selling a medical practice, a law or tax firm, or a business is a once-in-a-lifetime event for most people: the value of decades of work flows in a lump within a single tax year. That is exactly why the tax on it is so high, and exactly why it pays to know the legal levers before the purchase agreement is signed. German income tax law holds genuine reliefs for this case; combining them with a smart reinvestment changes the outcome markedly once more. This article ranks the levers in order.

How is the sale of a practice or business taxed?

The gain from the sale is fully subject to income tax. What counts for tax is the capital gain (Veräußerungsgewinn): the sale price less the costs of the sale and the book value of the business assets (§16 EStG, for members of the liberal professions in conjunction with §18(3) EStG). Because an established practice or firm usually carries little substance on its balance sheet, most of the purchase price consists of goodwill; almost the entire proceeds are therefore taxable gain. One important relief comes first: for natural persons the capital gain is generally not subject to trade tax. The burden arises solely from income tax, and there from the progression.

Which allowance applies to a sale from age 55?

Anyone who has reached the age of 55 at the time of the sale, or is permanently unable to work, receives on application an allowance of up to €45,000 on the capital gain (§16(4) EStG), but only once in a lifetime. The allowance also melts away: it is reduced by the amount by which the gain exceeds €136,000, and is fully consumed once the gain reaches €181,000. With typical six-figure gains from practice and business sales, little or nothing of the allowance therefore remains. The real leverage sits in the tariff relief of §34 EStG.

Fifth rule or reduced rate: which is better?

There are two tariff reliefs for the capital gain, with a right to choose between them. The fifth rule (§34(1) EStG) spreads the gain across five years arithmetically; but it only works while your other income is low, and evaporates almost entirely once you are in the top bracket anyway. Why that is so is worked through in Investing a severance payment tax-efficiently: the fifth rule, the IAB and the energy investment for the related case of a severance payment. Far stronger for most sellers is the reduced rate of §34(3) EStG, often called the 'half tax rate': the capital gain is taxed at 56 % of the average tax rate that would apply to your entire taxable income, but at least 14 %. The requirements mirror those of the allowance: age 55 or permanent inability to work; the relief applies to gains of up to €5 million and can likewise be claimed only once in a lifetime. Both reliefs must be applied for in the income tax return.

How does a reinvestment lower the tax in the year of sale even further?

An investment deduction (IAB) under §7g EStG lowers your other income in the year of sale and thereby amplifies both tariff reliefs. The mechanics: anyone planning a business investment, for instance via an own business or a stake as limited partner in a GmbH & Co. KG that acquires a battery storage system or a photovoltaic plant, deducts up to 50 % of the planned acquisition cost, no more than €200,000, from profit before the acquisition. Important for a precise picture: the IAB does not reduce the relieved capital gain itself; it arises in a different business and acts against your other income. That is exactly what gives it a double effect under the reduced rate: first, it lowers the other income where your marginal rate is highest; second, it lowers the entire taxable income from which the average tax rate is calculated, and with it the reduced rate on the capital gain. The full mechanics of the IAB, Sonder-AfA and declining-balance depreciation are broken down in IAB under §7g EStG: example calculation for battery storage; the requirements are covered in Investitionsabzugsbetrag: all §7g EStG requirements, and who can use it.

An example shows the size of the differences: a 62-year-old practice owner, capital gain €400,000, other taxable income of €200,000 in the year of sale. The allowance of §16(4) EStG lapses here because the gain exceeds €181,000:

In the example the IAB pushes the other income to zero; the reduced rate on the capital gain thereby falls from around 23.4 % to around 22.5 %, and the fifth rule alone looks positively modest against either variant of the reduced rate. An IAB of €200,000 presupposes a planned investment of at least €400,000 and is tied to a hard condition: it arises only through a serious, documented intention to invest and must lead to an actual investment within three years, otherwise it is reversed retroactively and interest is charged; the consequences are described in Reversing the IAB: what happens if you don't invest, deadlines, interest, ways out. And because a substantial part of the investment is carried by bank financing and the pulled-forward tax refund, the effective equity outlay often sits well below the nominal volume; that is set out in How much equity is actually required?.

Does a new investment endanger the allowance or the reduced rate?

No, because the allowance and the reduced rate require you to give up your previous activity, not to forgo new income. The condition for the reliefs is that you cease your previous professional or business activity in your previous local sphere of activity for a certain period (Federal Fiscal Court, judgment of 21 August 2018, VIII R 2/15). Continuing to work on a small scale is considered harmless under the case law if it accounts for less than 10 % of the average income of the last three years. A limited-partner stake in a commercially active energy project company is a separate matter: it is a different activity in a different income category and does not continue the practice or firm that was given up. How such an investment proceeds from the first enquiry to closing is shown in From first enquiry to closing: how a direct investment works step by step; how the income and the later sale of the investment itself are taxed is covered in After the IAB: How the ongoing returns and the sale of a direct investment are taxed. Whether the requirements of §§16 and 34 EStG are met in your specific case is for your tax advisor to clarify before the sale.

What applies to the sale of GmbH shares?

GmbH shares held as private assets follow a regime of their own: from a stake of 1 % the gain is taxed under §17 EStG in the partial-income procedure; 40 % remains tax-free, 60 % is subject to your personal rate. The allowance under §16(4) and the reduced rate under §34(3) EStG do not apply here. The reinvestment lever, however, stays the same: alongside a share sale, too, an IAB lowers the taxable income in the year of sale. Whether a different structure, such as a holding company, pays off before a planned sale is a question for your tax advisor with several years of lead time. If the proceeds already sit in a holding company after a sale, the follow-up question is whether the company or you privately should reinvest; that comparison is drawn in Invest through your GmbH or privately? The honest tax comparison.

What other levers are there when selling?

• Control the timing of the sale: the lower your other income in the year of sale, the stronger the fifth rule and the reduced rate work. A sale at the turn of the year, when no full annual profit is added anymore, can therefore save noticeable tax.
• Deploy the once-in-a-lifetime reliefs deliberately: the allowance and the reduced rate are each granted only once. Anyone holding several businesses, practices or stakes saves them for the largest gain.
• Consider a purchase-price annuity: if the price is paid as an annuity or in instalments, there is a choice between immediate taxation with the reliefs and deferred taxation of the payments as they flow. Which is better depends on age, tax rate and the need for security.
• Plan for loss carryforwards: existing losses can reduce the capital gain, but may then cost part of the tariff relief. That, too, belongs in the planning before the sale.
• Think a generation ahead: reinvesting the proceeds in an investment business of your own creates business assets that are largely exempt from inheritance and gift tax under §§13a, 13b ErbStG; how that works is shown in Passing on a direct investment: how German inheritance tax favours business assets.

A broader overview of legal planning options is given in Legally reducing your tax: the most effective strategies; why real assets are fundamentally interesting for reinvesting sale proceeds is set out in Real assets as inflation protection: what actually protects and where energy assets fit in. And the §7g lever is not confined to the year of sale: how it works in the working years before, alongside the running practice, is shown in Saving tax as a physician or dentist: the §7g lever alongside the practice, and alongside the running law firm in Saving tax as a lawyer or law-firm partner: the §7g lever alongside the firm. Whether and how the allowance, the reduced rate and the IAB combine in your situation, and which energy investment fits, belongs in a conversation with robust figures. That is exactly what we do in a non-binding first call: tax effect, effective equity outlay and project risk, worked through on your situation. We make no return guarantees.