Tax Planning for Physicians: Strategies to Keep More of What You Earn

When you buy commercial real estate with partners — other physicians, family, a small investor group — the entity you choose matters as much as the property. For most co-owned real estate, the answer is a limited liability company (LLC) taxed as a partnership, which a multi-member LLC is by default (Treas. Reg. § 301.7701-3), and the reasons are concrete.

Start with liability. An LLC walls off the property’s risks from your personal assets — important when you already carry the malpractice exposure of a medical career. The protection also runs the other way: in most states, a personal judgment creditor of a member in a properly structured multi-member LLC can reach only a charging order — a lien on distributions — and cannot seize the membership interest, vote it, or force a sale, which gives you real leverage in a settlement negotiation (Uniform Limited Liability Company Act § 503 (2006)). That charging-order protection is state-specific and materially weaker for single-member LLCs, where some courts have let a creditor reach the interest outright (Olmstead v. FTC, 2010), so the multi-member structure and the state of formation both matter in states that follow this approach. Then comes the tax structure. A partnership is a pass-through: there is no entity-level tax, so income and deductions flow once to your personal return (I.R.C. § 701), avoiding the double taxation of a C corporation (I.R.C. §§ 11, 301).

The decisive advantages, though, are the ones a partnership offers that an S corporation cannot:

1. Special allocations. A partnership’s operating agreement can allocate income, losses, and depreciation among the owners in ways that need not track ownership percentages, provided the allocations have substantial economic effect — letting the partners who can best use the deductions receive them (I.R.C. § 704(b); Treas. Reg. § 1.704-1(b)(2)). An S corporation must allocate strictly pro-rata by share ownership (I.R.C. § 1366(a)).
2. Debt in basis. Partners include their share of the entity’s liabilities in their tax basis, which raises the losses — including depreciation — they can actually deduct (I.R.C. §§ 752, 722). S-corporation shareholders generally cannot count entity-level debt in basis; only direct shareholder loans create debt basis (I.R.C. § 1366(d)(1)(B); Treas. Reg. § 1.1366-2). For leveraged real estate, this difference is large.
3. Members can join or leave, and contribute or distribute appreciated property without triggering tax in most cases (I.R.C. §§ 721, 731). The partnership can also adjust the basis of its underlying assets when an interest changes hands — the death-time version of which is explained next. S corporations are rigid by comparison, limited to one class of stock and no more than 100 eligible shareholders (I.R.C. § 1361(b)(1)).
4. The § 754 election: a stepped-up basis when a partner dies. Of these advantages, the basis step-up at death is the one most worth understanding in full. When a partner or LLC member dies, the heir inherits the partnership interest at its date-of-death fair market value — the familiar step-up that erases a lifetime of appreciation (I.R.C. § 1014). But on its own that step-up reaches only the outside basis: the heir’s basis in the interest itself. The partnership’s inside basis — its own basis in the building and its depreciable components — does not automatically change. Left unaddressed, the mismatch is expensive. The partnership keeps depreciating the same low basis, and the deceased partner’s share of the built-in gain, including every dollar of prior depreciation recapture, still waits to be taxed when the property sells.

A § 754 election closes the gap. With the election in place, § 743(b) gives the inheriting partner a special adjustment that steps up their share of the inside basis of the partnership’s assets to fair market value as of the date of death (I.R.C. §§ 743(b), 754; Treas. Reg. § 1.754-1). For real estate the payoff is concrete: the heir’s share of the building receives a fresh depreciable basis to write off again, and the built-in gain attributable to the inherited interest — recapture included — is wiped out rather than deferred. The adjustment belongs to the heir alone and leaves the other partners’ basis untouched.

An S corporation cannot do this. An heir who inherits S-corporation stock gets a step-up in the stock under § 1014, but the Code offers no way to push that step-up down to the company’s assets — there is no S-corporation counterpart to the § 754 election. The corporation keeps depreciating its old basis, and the built-in gain stays locked inside the entity. One caution rides with the benefit: the election is made by the partnership on a timely-filed return, and once made it binds all future years and applies to distributions as well as transfers, so it can also require downward adjustments when assets have lost value (I.R.C. §§ 734(b), 754). For a physician who expects to hold appreciating real estate for life and pass it on, the election is almost always worth making — and the operating agreement should require the manager to make it.

Co-owning in your own names or on a casual handshake invites both liability and disputes. A well-drafted LLC operating agreement, taxed as a partnership, gives you protection, single-layer taxation, and the allocation flexibility that makes real estate worth owning together.