Will a Cost Segregation Study Benefit My Self Storage Property?
Cost segregation is a strategy that self storage owners and operators use to separate assets for tax saving purposes. The concept of cost segregation is not complicated. However, the implementation of the process is complex and should be conducted by a team of experienced engineers.
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.”
To simplify, a tax advantage gained by owning a self storage property, based on depreciation, provides benefits for 39 years. The components of a building, however, will depreciate at different rates. Your roof or HVAC system may need to be replaced before your windows or flooring. This is where cost segregation comes in.
How Does Cost Segregation Work?
To simplify this process, cost segregation is organized into the following steps:
- To begin a cost segregation study, all of the component parts of a building must be identified. This includes large elements such as windows, doors, and HVAC systems and moves all the way down to include small items such as locks, signs and counters.
- These components are then grouped by type. For example, classifications may include building, fixtures, land, and equipment.
- 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. This is why you need the expertise of experienced professionals.
- After classifying the assets, depreciation is calculated and the assets are grouped according to whether their useful life is 5, 7 or 15 years.
- The final step, and the most complicated, is determining what portion of the building’s purchase price should be allocated to each class. This provides the owners with 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.
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 renovations or improvements to the properties.
- A decrease in a self-storage facility’s income taxes provides the owner with the ability to invest the savings in capital improvements, reduce debt, or simply improve cash flow.
- Increased depreciation provides immediate reduction in federal income tax.
- Taxes on gains are deferred to a lower rate
Does the Type of Property Affect the Tax Savings?
Property type can have an affect 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 actual assets and values on each of the components within the property.
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 Me?
Since self storage properties vary in type and size, tax savings depend on the type of building, acquisition cost, and length of ownership. Generally, reclassification percentages will range from 15% to as high as 40%.
Whether reducing debt, optimizing cash flow, or investing savings in capital improvements, self storage properties can reap significant benefits from a cost segregation study. Get advice from your investment company, and then choose a reputable firm to be sure that all IRS requirements are met. Request a detailed benefit analysis from a qualified and experienced firm 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.