Self-storage properties are generally considered real estate, not depreciable business assets. This means that you cannot write off the cost of your self-storage property as a business expense for tax purposes.
Cost segregation, however, enables you to take advantage of tax benefits associated with real estate investments. Cost segregation is the classification of certain components of your self-storage property as depreciable real estate rather than simply an unamortized cost.
A more complete definition of cost segregation, according to Heidi Henderson, is “Cost Segregation is the process of identifying personal property vs. real property, and individual building components for tax purposes, rather than treating a building purchase as one large asset. This determination allows a property owner to depreciate their assets over the useful life of each asset instead of assuming that the entire purchase amount applies to one long-term asset.”
The concept of cost segregation is not complicated. Self-storage properties tend to have many non-revenue generating components, such as concrete floors, HVAC systems, and roofing. These and many other elements add very little to the value of the property.
Cost segregation is a strategy that self storage owners and operators use to separate assets for tax-saving purposes. However, the implementation of the process is complex and should be conducted by a team of experienced engineers.
Considerations Prior to a Cost Segregation Study
Before beginning cost segregation, there are a couple of things that should be considered.
First, you should figure out whether the property is owned by someone else or if it’s still under lease. The next step is to calculate depreciation and group assets according to their useful life.
Secondly, it is important to understand the building’s cost. If the building’s cost is too low, there may not be enough items to re-classify and increase the building’s value.
In any case, always seek professional advice from an experienced company that has a successful history with the self storage industry.
How Does Cost Segregation Work?
The process of cost segregation begins with the following steps.
1) To begin a cost segregation study, all of the component parts of a building must be identified. This includes windows, doors, and HVAC systems moving down to include small items such as locks, signs, and counters.
2) These components are then grouped by type. For example, classifications may include buildings, fixtures, land, and equipment.
3) Determine if each component is considered a structural element or tangible personal property. This is not as simple as it sounds. It’s easy to make errors when classifying certain types of assets. You need the expertise of experienced professionals.
4) The next step is to calculate depreciation and group assets into categories according to their useful life. Assets with a useful life of 5 years, 7 years, or 15 years will be grouped together.
5) The final step is to determine what portion of the building’s purchase price should be allocated to each class. This provides the information needed to claim accelerated depreciation on the components that are expected to wear out prior to the 39-year point.
How to Move Forward with a Cost Segregation Study
Regarding cost segregation, the IRS has very strict rules and regulations in place. An IRS publication, Cost Segregation Audit Techniques Guide, outlines the importance of an accurate and complete study. As stated above, these studies should be performed by people with specialized knowledge in this area.
Contact Pinnacle Storage Managers to advise you as to whether a cost segregation study is right for your business.
What are the Benefits of Cost Segregation?
Self storage property owners can increase cash flow by accelerating depreciation through cost segregation studies. This extra cash flow allows for more opportunities to purchase additional investments and perform necessary property improvements.
Decreased income taxes provide the owner with the cash to invest in capital improvements and reduce debt.
Increased depreciation provides an immediate reduction in federal income tax.
Taxes on gains are deferred to a lower rate
Does the Type of Property Affect the Tax Savings?
The property type can have an effect on tax savings. Interior, climate-controlled self-storage properties will see a higher reallocation percentage amount than a boat and RV storage type. The allocations are based on the actual assets and values of each of the property components.
What Information is Required to do a Cost Segregation Study?
The information required to perform a cost segregation study is minimal. Only a closing statement or HUD is required for a recent purchase. New Construction projects typically require cost breakdowns as well as total costs for construction and development. However, individual invoices are not required.
How Much Will a Cost Segregation Study Save?
Self storage properties vary by type and size. Tax savings depend on the type of building, acquisition cost, and length of ownership. Reclassification percentages can range from 15% to as high as 40%.
Self storage properties can reap significant tax benefits from a cost segregation study.
It’s essential to choose a reputable firm that knows how to meet IRS requirements. Request a detailed benefit analysis from a qualified and experienced company that has a history with self-storage properties. It may be a bit more expensive, but the support of a reliable provider will be worth the additional cost.