Generating Cash Flow Through Cost Segregation: Tax Planning for Self-Storage Owners

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By Jerome H. Kootman

Many self-storage owners are becoming increasingly familiar with the powerful cash-flow improvement concept of accelerated depreciation deductions resulting from cost segregation. Recent developments, including 50 percent and 100 percent first-year bonus depreciation, continue to enhance the opportunity to generate significant additional cash flow during these difficult economic times. This additional capital can be used for renovations, buying new property and strengthening the balance sheet.

This article will discuss the latest developments on the lucrative first-year bonus depreciation regulations and provide examples on how to increase cash flow through optimal year-end tax planning.

What Is Cost Segregation?

Cost segregation is a cash-flow improvement strategy that maximizes depreciation deductions for all buildings. Dramatic cash flow benefits can be achieved by reclassifying components of the “building” into their proper depreciation schedules of five, seven and 15 years, using accelerated depreciation methods. While this may seem to be inconsequential at first, the cash-flow effect of this reclassification is significant and immediate.

Benefits of cost segregation include:

  • Accelerated depreciation expense
  • Reduced corporate and/or individual income taxes
  • Increased cash flow
  • Quicker return on investment

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, storm drainage, fencing and landscaping, as well as personal property like signage, security systems, movable partitions, certain floor coverings and special climate-control systems. The list is extensive and requires a cost-estimating background and familiarity with tax regulations to maximize the benefit.

First-Year Bonus Depreciation Update

The federal government reinstated first-year bonus depreciation for eligible properties (recovery period of 20 years or less) acquired after Dec. 31, 2007. The goal of this initiative was to incentivize growth and stimulate capital expenditures. The bonus depreciation rate was originally set at 50 percent, which meant half of the cost basis could be written off in the first year, with the remaining balance recovered over the typical depreciation period of five, seven or 15 years, depending on the particular asset.

The bonus depreciation rate increased to 100 percent in September 2010 but reverted back to 50 percent as of Jan. 1. Any purchase of equipment, or in-process construction/renovation projects, needed to be in service prior to Jan. 1 to take advantage of the more favorable regulations.

The next milestone is Jan. 1, 2013, when the 50 percent rate expires altogether and bonus depreciation will no longer be permitted. While, it is possible the federal government will move to extend the expiration date as it has in the past, this warrants monitoring for future developments. Knowledge of the various first-year bonus depreciation scenarios is crucial for proper capital expenditure planning.

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