If it were possible to expense the entire construction cost of a new facility the year it’s incurred instead of capitalizing it, most self-storage owners would do so in a heartbeat. Although that’s not feasible, cost-segregation studies provide a good—and absolutely legal—alternative.
Cost-segregation studies allow owners to obtain the most efficient write off of expenditures as allowed by the IRS, resulting in increased depreciation in the earlier years of the project and increased return on investment. Most property owners spend a fair amount of time managing expenses and other financial parameters they can control but neglect to consider how depreciation can factor into the equation. The reason is they assume their accountants have maximized their depreciation, when in fact many accountants are not fully familiar with cost segregation. This isn’t uncommon as the cost-segregation industry has only recently become more widespread and available to all.
Cost segregation is an engineering-based approach to identifying assets within a facility that can be reclassified into a much shorter depreciation class than the building itself. Non-residential properties—and everything in them—are generally depreciated using a straight-line method over 39 years. A cost-segregation specialist can maximize the inherent tax benefit by identifying, quantifying and segregating the personal property components of a facility, resulting in depreciable lives of five, seven and 15 years using accelerated depreciation.
This is not simply a matter of classifying equipment to a five- or seven-year recovery period. Items typically reclassified include land improvements such as paving, curbing, site lighting, storm drainage, fencing and landscaping; and personal property such as signage, security systems, certain floor coverings and special climate controls systems. The list is extensive.
The following table illustrates the financial benefits of performing a cost segregation study for a sample $5 million self-storage facility for which you could reclassify 30 percent of the cost basis to a shorter life.
The decision to spend $7,000 to $9,000 and save $286,171 becomes very easy.
Special tax benefits specific to self-storage units should also be considered. Certain units are constructed in a manner to be subsequently relocated. The tax courts refer to several key factors in determining whether property is permanent, which would result in a 39-year recovery period. If the taxpayer can demonstrate the property is capable of being moved with minimal damage and is designed to be relocated, he can write off the costs using a seven-year recovery period. Therefore, if a significant portion of your facility is constructed in this manner, it can result in huge tax savings.
Timing Is Everything
The best time for a study is when a facility is constructed or acquired. It’s also possible to obtain these benefits for properties in your portfolio for up to 15 years. A retroactive study can be performed without the problems associated with amending prior year tax returns or IRS approval. You can claim the difference between the allowed depreciation and what you actually claimed in prior years on your current tax return and receive a big tax savings.
To do so, a cost-segregation specialist uses an engineering-based approach, as specified by the Internal Revenue Service, and examines architectural and engineering drawings, cost data and other project specifications for potential asset reclassification. If cost data is not available, estimates may be used.
The government is doing its part to help real estate owners maximize the benefits of investing in properties. Recent IRS pronouncements have enhanced this tax strategy and made cost-segregation studies an even more beneficial method to increase cash flow and profitability of a project.
Ask yourself the following questions to determine if your facility is a candidate for a cost-segregation study:
- Is the cost of the facility (excluding land) at least $1 million?
- Have I purchased, constructed or renovated any facility in the past 15 years?
- Do I plan on retaining this facility for at least the next few years?
- Do I have net income that is currently taxed?
Cost segregation will increase your cash flow and return on investment if you answered “yes” to the above questions. If so, explore this and other tax advantages with a qualified professional, competent in design, construction, auditing and estimating procedures related to self-storage construction.
Jerome H. Kootman is a certified public accountant and managing tax director for Cost Recovery Solutions LLC, a specialized engineering firm that provides cost-segregation services. He has provided cost-segregation studies for hundreds of clients ranging from small businesses to Fortune 100 companies. For more information, call 732.548.3855; e-mail jerry@CRScostseg.com; visit www.crscostseg.com.