Cost segregation benefits self-storage facilities by increasing cash flow through accelerated depreciation.
Cost segregation is not new. It has been in existence since 1954 when the IRS allowed for certain personal assets to be accelerated into a shorter life class. However, it wasn’t until Hospital Corporation of America sued the IRS in 1997 and won that the IRS revisited the issue of accelerated depreciation. Subsequently, after the Tax Act of 2004, the IRS’ chief counsel issued a memo stating that “…cost segregation, for it to be properly applied, had to involve those with competencies in architecture, engineering or construction and/or construction techniques, in order for personal property assets to be accurately identified and segregated.”
There have been many court rulings and challenges since the IRS acquiesced to the HCA suit. Cost segregation has stood the test of time and challenge. Cost segregation is the only accepted and IRS-approved method of reclassifying assets. Utilizing an engineering-based study assures a self-storage owner of getting the maximum benefit allowable.
Self-storage facilities fall into two typical categories; climate-controlled and non-climate-controlled. Climate-controlled self-storage facilities are more expensive to build and operate. They allow for a wider variety of storage options where special conditions are required, say for computer equipment or books and photographs. It is this type facility where cost segregation can often uncover as much as 85% qualifying tangible personal property. Tangible personal property is considered a 5-year asset under IRC Sec. 1245. Real property is considered IRC Sec. 1250 property that is depreciated over 39-years. Some qualifying assets under IRC Sec. 1245 include specialty electrical systems & HVAC, security system, fencing, solar/wind systems, landscaping, and much more. These assets qualify for accelerated depreciation under MACRS. MACRS is Modified Accelerated Cost Recovery System and is the method of depreciation IRS requires for self-storage facilities. Non-climate-controlled self-storage facilities typically realize upwards to 65% qualifying tangible personal property. So, both type self-storage facilities benefit greatly from cost segregation applied.
The self-storage real estate market has drastically changed over the past decade. Owners and investors looking to acquire a self-storage facility need to understand the buying process. This includes due diligence, capitalization (cap) rates, self-storage appraisals, and methods for determining property value. Cost segregation delivers here again. When cost segregation is applied, the owner receives a detailed cost segregation study report. This cost segregation report itemizes all building components used in construction. Thus, the cost segregation report is vital in confirming an accurate appraisal. This cost segregation report will justify a lower real estate tax bill. Tangible personal property is taxed at a lower rate than real property. This cost segregation report will justify a lower property insurance premium. Tangible personal property costs less “per thousand” of property value to insure over real property. The cost segregation report also comes in handy in case of fire or theft. It accurately identifies all building components for the insurance adjustor. This makes it easy to prove asset values and thus, determine qualifying losses for compensation. Cost segregation is an integral component in acquiring a self-storage facility.
In summary, cost segregation benefits self-storage facilities in many ways:
- Cost segregation identifies all building components qualifying for accelerated depreciation
- Cost segregation is basis for accurate appraisal
- Cost segregation lowers real estate tax bill
- Cost segregation lowers property insurance premium
- Cost segregation ensures accurate identification of assets in case of fire or theft
- Cost segregation delivers cash in the critical first five years of self-storage business ownership
Cost segregation is a vital tool that any self-storage owner should take advantage of today. Cost segregation is just as a vital a tool to the one considering self-storage facilities as an investment. Again, the first five years of ownership is always the toughest. Cost segregation puts more cash in the hands of an owner than any other business tool…guaranteed!
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Contributed by: Jeffrey M. Hobbs, Director