As our nation begins to emerge from the economic downturn, self-storage owners should consider some of the tax advantages that can be realized using cost segregation, and the recent changes to regulations that allow net operating losses to be carried for up to five years.
Under the new regulations, if you’ve paid taxes over the last few years and are now operating at a net loss, you can apply last year’s losses back five years. You may also want to consider using cost segregation to increase net operating loss and gain the tax benefit.
This, in turn, may free up some capital to take advantage of what every real estate investor sees as the second coming of the Resolution Trust Corp. of the late 1980s and early 1990s.
Traditional, straight-line 39-year depreciation has generally been the norm for self-storage owners. But over the last few years, many owners have considered cost segregation and accounting modification to free up the capital necessary to take advantage of the real estate investment climate.
The following questions will help you determine if your property is a good candidate to benefit from a cost-segregation analysis. If your answer is “yes” to these, you may be able to apply cost segregation to your facility.
- Is your facility worth more than $1 million, excluding the land?
- Do you plan on holding on to the facility for the next few years?
- Have you purchased or built your facility in the last 15 years?
- Do you have taxable income?
What Is Cost Segregation?
Cost segregation is an analysis performed by an engineer to determine if various facets of your buildings can be reclassified into five-, seven- or 15-year depreciation schedules. The goal is to increase the depreciation amount in the initial years of your investment and decrease your tax bill. But remember: Only the improvements can be depreciated, not the land.
Components such as asphalt paving, sidewalks, curbing, fencing, security lighting and underground utilities have specifically been identified by the IRS as improvements with a 15-year depreciation schedule. Other components such as security gates, certain types of flooring and alarm systems can be reclassified into a five- to seven-year deprecation period.
This increase in depreciation essentially defers your taxes due and, therefore, has the same effect as borrowing money from the U.S. government with no interest. Furthermore, if your accountant has been depreciating your facility using straight-line 39-year depreciation, you can file IRS Form 3115, “Change of Accounting,” and catch up this year on all the accelerated depreciation since you purchased or built your facility.