By Mark de Stefanis
Cost segregation has long been regarded as one the best tax strategies available to self-storage owners. It’s better than found money. It’s your money! Whether you acquired a facility after 1986, are planning to buy a facility, or are embarking on a building or replacement program, cost segregation should be part of your strategy to maximize cash flow.
This method of accelerating the depreciation deduction has withstood the test of time and is endorsed by the IRS. But get this! Recent changes buried in the repairs and maintenance regulations are like cost segregation on steroids. The new regulations favor self-storage owners by allowing a write-off on retired structural improvements. This major change will have a positive impact on all commercial real estate and is available now and on a retroactive basis. It also helps level the playing field for facilities that compete against real estate investment trusts (REITs).
The new regulations allow self-storage owners the ability to write off the adjusted basis of retired structural components (doors, windows, roofs, fixed partitions, flatwork, etc.). This is a significant departure from past practices that required taxpayers to continue to depreciate structural improvements over the remainder of the 39 years even though the items no longer exist. On the flip side, the regulations also provide some complex guidance related to whether an item is deductible as routine repair and maintenance or must be capitalized.
Retirement of Structural Improvements
Ever since the end of the component-depreciation system, owners have complained about a requirement to continue depreciating physically abandoned assets. Those of you who’ve been around for a while may recall that the system conjoined the estimated useful life of an asset and its recovery period. This alleviated the concern of recording a loss on the retirement as long as the asset performed within its life expectancy. However, under the Accelerated Cost Recovery System (ACRS), the link between the estimated useful life and the recovery period was lost. This resulted in owners continuing to depreciate items that no longer exist.
The doors on a self-storage facility take a great deal of wear and tear and are the most common items that require replacement. Unfortunately, IRS guidance still requires self-storage owners to capitalize the costs of replacement doors. This was not an issue under the component-depreciation system if the doors performed according to their specification (15 years), since the doors were 100 percent depreciated when it was time for replacement.