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Retirement strategies for small-facility operators

January 29, 2009
by Michael S. Collins, CPA
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Turning the senior living business into a retirement nest egg

Senior living owners and operators contend with a variety of financial issues on a daily basis—everything from meeting monthly payroll to managing cash flow, financing future growth, maximizing reimbursement rates, mortgage financing, and meeting the personal financial needs of the owner.

For many owners, particularly those who own and operate on a small to medium scale, the business is often a nest egg crucial to their retirement. These owners may not have set aside other funds for retirement, and instead plan to rely on proceeds from the business when it is time to retire. But, how does one turn this business into retirement income? When is it time to give up these 60-hour weeks and retire?

Issues that surround an owner’s exit from the business are the type with which they may be least prepared to deal. Frequently, owners may have a background in healthcare but lack expertise in the benefits of certain financial strategies. For example, they may not be aware of the financial implications if they were to sell, or even be aware of their financial resources after a sale. In our work, we regularly discover that owners are often surprised when they learn that they could sell their facility and retire sooner than they thought because they had not understood the value of the property or the strategies they might employ to maximize retirement income from the sale.

Many believe that all they can do is sell and reinvest the proceeds into something else. While that is true, there are ways to derive more benefits, generate more income, and reduce or defer the tax burden when conducting a sale. Here are a few strategies worth considering.

Real estate exchange

A real estate exchange is simply a trade. In this instance, the owner exchanges the property where they work and put in many hours every week for a more passive real estate investment. Here’s the good part: You are giving up your job, yet retaining the income. In most cases, all of the owner’s gain can be deferred for tax purposes and shifted into the new property.

Some senior care owners that we’ve represented tended to shy away from this type of arrangement at first because they did not want to be involved in property management. We have found, however, there are solutions for which the owner’s involvement is very limited. There are companies that create such real estate exchanges with limited management requirements on the part of the owners.

A recent client operated 10 assisted living homes where the owners were involved in 60+ hours per week. They were tired and wanted out. When they exited the business, they exchanged it for a shopping center and a retail building, and are now collecting monthly rent checks from a number of tenants. Their management company takes care of leasing, maintenance, and other daily operations. The bonus for these owners is twofold: an increase in salary because of how they structured the transactions, and a much easier lifestyle without the daily demands of their business.

In another example, a client exchanged his long-term care facilities for a hotel that is managed by another firm, again, trading endless hours of work for rent income, and a more relaxing lifestyle.

With a real estate exchange, the equity that owners have in their business is still working for them—they are just leveraging it, moving equity from one investment to another and from a high-involvement to a low-involvement investment. The objective in such a transaction is to maintain or increase the income you generate from that investment in a safe and secure fashion. Remember that tax laws include detailed requirements for tax-deferred exchanges; sellers should consult with their tax advisor to ensure compliance.

Installment sale

In an installment sale, a seller receives a down payment and a promissory note from the buyer for the purchase of an appreciated asset where at least one payment is received in the years after the year in which the sale occurred. An installment sale allows the seller to defer gain to the year that payment is received, helping sellers defer capital gains tax rather than having to pay the entire tax in the year of the sale.

In the senior care market, however, an installment sale can be a somewhat unattractive choice. The primary drawback is that the seller takes on the risk that the buyer may not fulfill the terms of the agreement. If the buyer defaults, the seller may have to take back the business. For long-term care owners who were hoping to relax and retire with the sale of their business, this can indeed be a negative outcome. Yet, the benefits of an installment sale can outweigh the risks when structured properly, as follows.

Structured sale

In a structured sale (also known as an ensured installment sale), the transaction is guaranteed and there is no threat of a bounce-back. Here is how this works: Generally, the buyer purchases an annuity from a Triple A-rated insurance company. The seller then receives cash through the annuity. The buyer’s obligation to pay is transferred through the annuity, and the seller is reassured that payments will be made regardless of what the buyer does or how the business turns.