Self Storage- Cost Segregation Basics

Would prefer to write a post on how we cleared 8 to 12 inches of snow at 4 locations in 4 hours, but that's not going to happen. Have about 3 inches on the ground in the last 3 hours. The rest is supposed to fall through now, 12:30 pm to 6 am. All of the equipment is filled up. Skid steer engine heater is plugged in. Literally just waiting for snow to fall. So writing a post on Cost Segregation related to Self Storage. This is just the basics. Read a lot of other posts on Cost Segregation, but never saw any detail or summary statements/break downs.

Basics.- Anyone wanting to get real technical, please write a separate detailed post. KISS- Keep it simple.

Cost Segregation- Dissecting an asset into its different cost components as you will see below. (Fence, Storage buildings, electric/lights, roads, etc.)

Why?- This is to take advantage of IRS early depreciation tax write-offs. Example: If we had $15,000 of security equipment, versus depreciating it over x years, we write it off in year one.

Which Assets can we take Early depreciation?- Below are the IRS asset class life's. Any asset with a life of 15 years or less can take Early depreciation. We will be more descriptive in the Self Storage analysis below.

A. 3 year/5 year/7 year/10 year/15 year

B. 20 year/27½ year Residential rental property/ 39 year Nonresidential real property

Benefit?- Making the math easy, so disregard incongruities. Say the above $15,000 had a 10 year life (KISS). Then your depreciation would be $15,000 divided by 10 years (KISS- not bringing in accelerated tax methods of depreciation); then your first year depreciation expense would be $1,500. With early write off, it would be $15,000. In year 1 you get to take an additional $13,500 ($15,000 - $1,500) of excess depreciation. If your tax rate is 30% (KISS), then you saved $4,050 tax/cash ($13,500 x 30%).

Carryforward- If you don't have the applicable income to utilize all of the $13,500 excess expenses, you can carry forward the tax benefit into future years to use.

Recapture- If you sell this property early, then you may have to recapture some of the excess early depreciation taken in prior years.

Cash Flow- Self Storage is usually Cash poor in the first year or two, and then Cash rich in later years. By taking this early depreciation thru Cost Segregation, you are reducing your income tax payments (Cash) in the early years, and you are increasing your Taxable income in later years since you will have less depreciation expense then (when you have more cash to pay taxes).

Date Placed in Service- If your developing a project and want to do Cost Segregation for the Current year, have a discussion with your Tax Accountant as to the date your assets are "Placed in Service" and when you can do the early depreciation write off. Not all projects get completed based on 12/31 tax year.



We will use the following Budget numbers for a Self Storage Development.
We will come back to an existing Self Storage location's "Purchase":


Self Storage Development:

Key- have your vendor or vendors bill you separately by asset type.

Keep in mind, Cost segregation is already performed if you are building a new location and have the Vendor/Vendors bill you separately by asset type. It becomes a Tax accounting exercise after that.

A few discussion points:
a. Land- is not depreciable, thus not part of the discussion.
b. Magnitude of order- Landscaping below is $5,000; and the Concrete Roads are $676,000. Both can be written off with early depreciation. Keep the integrity and conciseness of your documentation at a higher level for your larger magnitude write offs.
c. Buildings- Material, foundation and Erection components cannot be separated and are all classified under the same asset and same life.
Use the below list and expand on it with your Tax accountant, to help with your segregating the costs.

This is an example, for discussion only.Adjust all of the above to your local market and situation.A. Self Storage Project WorksheetDrive up StorageNotes:Land$200,0004 acres at $50,000/acreSurvey$7,000Site, elevation and building layoutFence$30,000Black chainlinkGate system$25,000Automated rolling 20ftEngineer$30,000Dirt work$15,000Building demo$Electrical- site$7,000Electric poles$Security$10,000Storm drains$150,000Water$5,000Water line$30,000Fire Hydrant$3,000Sewer$7,000Sewer Line$7,000Buildings$1,180,800Phase 1 2 acresOffice$25,000Office setup$5,000FootingsRoadsGravelAsphaltConcrete roads$676,1336 inch Cubic yards, framed, poured, sawn,Retention Pond$5,000Landscaping$5,000Road Sign$15,000For highway 55mph billboard signTotal$2,437,933

Self Storage Purchase:

Same situation as above, but we are purchasing a pre-existing Storage location. All of the items below, you should discuss with your Tax advisor, there are more implications, than just the topic of Cost Segregation.

A. Try to purchase the "Assets" and not the Business. This gives you a chance to segregate the assets of the business and gives you a little more IRS credibility on Cost segregation.

B. Try to put in a Non-Compete agreement. This can be amortized/depreciated for tax purposes. Work to move less value out of "Land"- not depreciable or Buildings- Longer lives.

C. Create Assets from the Total purchase price. Example: Accounts Receivable is normally just part of the purchase price and not considered other than cutoff date. Same for existing Lawn mowers, furniture, etc. Create Assets to absorb more of the purchase price so that less of the value goes to the Long Life assets that can't have early depreciation write off. Forget the impact to the Seller, they need to catch that.

D. Whether you purchase the "Assets" or the "Business"; you might still decide to do a Cost Segregation Study. Look at the different line items above and consider their "Order of Magnitude ($)" and then think of the time/Cost it might take for a Cost Segregation study. For example: if you give the same amount of due diligence to establish a value for Concrete Roads ($676,000) versus Landscaping ($5,000); it would actually take more time to do the Landscaping. Make sure you specify the degree to which you do/don't want to capture these segregation items; and the degree to which you want support should you meet an IRS challenge with your Professional.

Well it's lunchtime and I'm going to plow some snow before it gets to deep.

************03 12 2022**********

We wrapped up one of our Self Storage build projects.  Below is a summary of the costs:

Building      $1,422,000

Roads          $  722,000

Electric       $  121,000

Plumbing     $  103,000 includes storm drains

Landscaping$     8,000

Signs          $     5,000

Fence       $    77,000

Security    $   79,000

Mower       $     5,000

Retaining wall 36,000

Waterline  $  113,000

Which assets can you do early writeoff?

The next question becomes which of these items are IRS 15 year lives or less. 

How Fast can you write them off?

They can then be written off or depreciated in 1 year or over 5 years.

How do you identify the cost by asset type?

We built this location and were the general contractor, thus cost segregation for us is easy.  Its just a matter of categorizing our asset types by invoice and giving to our Tax accountant to determine 15 year or less properties to write-off. 

If you bought the operating location, how do you identify the value by Asset type?  How much effort do you put into this?

But if you were to look through all of the invoices for the above, by far the Landscaping had the most invoices.  My point is, if you do a cost segregation determine both the time and degree you wish to estimate, document and segregate your study ahead of time for yourself or for the firm you use.  You might even say, don't do landscaping, for example.

Why do Cost Segregation and early write-off?

A.  This reduces your taxes in the current period but you will pay more taxes in future years since you don't have this depreciation.  Thus this is just a timing difference of when you pay taxes.  Since you are in the Rent up Phase at the beginning, thus cash poor, its a good time to pay less taxes.

B.  Big "If" the tax rates stay the same, you get the advantage of Time value of money, paying less tax now versus more taxes in later years.

C.  Offset other projects.  We had sales last year on a Subdivision of land lots we sold.  This land was bought back around 1993 and 2012.  The land base was low and we sold for a lot as subdivided lots.  We would have had to pay significant income taxes, since we decided not to do a 1031 exchange on this sale.

What if you have to much write-off in the first year and have a loss?

You can "Carry Forward" the unused tax loss to the next years, till you use it up.

Won't your banker or investors look negatively on having losses for the first year or two?

No.  They understand the tax advantage of early writeoffs.  Plus they are worried about your "Operating" profit/loss; which does not include Depreciation expense.

What is the sum total of all of what I just mentioned?  I don't know.  Have our meeting with our Tax accountant on Tuesday and he will roll all of the projects and numbers together and see where we are at. 

Hopefully we don't have to pull out our checkbook and pay any taxes.