By Mark de Stefanis
Usually anything that occurs on Friday the 13th is associated with bad luck. Now, let’s spice it up by telling you it’s an IRS announcement. However, this is good news for self-storage owners.
In September, the IRS issued the long-awaited Final Tangible Property Regulations. The complex set of regulations provides self-storage owners the opportunity to write off certain repairs, improvements and routine maintenance. Furthermore, a proposed set of regulations were also issued that allow a write-off equal to the adjusted basis of retired assets. As we revise our systems to accommodate the new rules, taxpayers can transition without fear of an IRS challenge for the next two years.
The new regulations are part of a process that started more than six years ago to align court decisions with treasury regulations. They were effective as of Jan. 1, 2014, and include a number of safe harbors that allow taxpayers to deduct costs that meet certain criteria, protect against audit scrutiny and reduce capital gains taxes. None of the new rules modify the benefits associated with a taxpayer’s ability to accelerate depreciation on improvements using a cost-segregation study.
De Minimis Safe Harbor Election
A de minimis safe harbor has been established for all costs paid to acquire, produce or improve a unit of real or personal tangible property up to maximum of $500 per item (taxpayer without audited financial statements). This safe harbor can be used for the purchase of a computer, printer, cash register, tablets or other costs that improve a unit of property as long as the item does not exceed the maximum threshold.
If the taxpayer is a self-storage real estate investment trust (REIT) for which an audited financial statement is required, the benefit soars to a write-off of $5,000 per item. There's no limit to the aggregate amount that can be deducted. Caution: If you elect to capitalize and depreciate the costs, you may incur unnecessary capital gain taxes.
Routine Maintenance Safe Harbor
Under the new regulations, an amount paid for routine maintenance on a building is deductible if it’s recurring and anticipated over a 10-year period to keep the building structure or system in ordinary efficient operating condition. Routine maintenance activities include inspection, cleaning and testing of the building structure or each building system, and the replacement of damaged or worn parts with comparable and commercially available replacement parts. Activities are routine only if the taxpayer reasonably expects to perform them more than once during a 10-year period. Factors to be considered while determining whether maintenance is routine include the recurring nature of the activity, industry practice, manufacturer’s recommendations and the taxpayer’s experience with similar or identical property.
No matter how well the facility is laid out with posted warning signs, pavement directional arrows and pipe bollards placed in high-risk areas, buildings still get hit, doors are dinged, partitions become dented and replacement parts are required. Prior to the issuance of the new regulations, each time a self-storage owner replaced a panel or door, he had to capitalize and depreciated the property over a 39-year period. Now, if he can support that these purchases are routine due to the nature of the replacement, the costs may be deducted.
Small Taxpayer Safe Harbor
A small taxpayer is able to deduct building repairs, maintenance and improvements up to the lesser of $10,000 or 2 percent of the adjusted basis of the buildings For example, a five-year-old facility that originally cost $1 million has an adjusted basis of $17,400.
- 39-year period minus 5 years = 34
- 34 divided by 39 = .87
- 1,000,000 multiplied by .87 = $870,000
- 2% of $870,000 = $17,400
Of note, if the taxpayer has more than one facility in the legal entity structure, he may split up the properties and potentially double the safe-harbor amount.