In todays self-storage market, with spiking steel prices and an upward trend in interest rates, facility owners need to consider every money-saving technique available. Of course, the best method is the one that does not require you to spend money to save money.
Over the past few years, cost segregation of depreciable assets has been a hot button in the self-storage industry. We have done a good job of breaking out expenses, such as fencing, pavement, software, soft costs, signage, etc., to maximize our write-offs according to IRS depreciation codes. The major component that has been neglected, however, is the actual building.
With a true-tax lease, you can accelerate the write-off of your storage buildings from 39 years down to the actual term of the lease. Most leases are structured between six and 15 years, essentially doubling or even tripling your write-off for the same dollars invested, which is your building cost.
What Is a True-Tax Lease?
A true-tax, or operating, lease under IRS regulations is a contract entered by the lender (lessor) and the customer (lessee), who has the right to possess and use the leased asset (the building) in exchange for periodic payments over a specific time table. A true-tax lease is separate from capital (dollar-buyout) leases because the lessor is treated by the IRS as the owner of the asset for federal tax purposes and permitted to claim depreciation on it.
With the above criteria met, the lessee is able to deduct 100 percent of all rental payments as an operating expense for federal tax purposes. This is the basis behind giving the lessee the opportunity to expense, in most cases, the largest cost of a new facility over a much shorter time frame than the 39-year depreciation method.
To qualify as true-tax, a lease must comply with the IRS guidelines. If the criteria are not met, the lease must revert back to more traditional financing and write-offs. Below are some general conditions. A lease will not qualify as true-tax if any of the following are true:
- The lessee has any equity in the leased asset.
- The lessee overloads payments in a specific time period during the lease term.
- The lessee receives ownership upon completion of all payments.
- The lessee has an option to buy the asset at an agreed price in the beginning of the lease period.
- The lease states interest and principal or any payment that could look like interest and principal.
- The lessee pays much more than current fair rental value for the leased asset.
Tax deductions are easy to figure with a true-tax lease because the lessee writes off the full lease payment. The tax savings of a lease are calculated by multiplying the payment by the effective income-tax rate. The effective rate should also include any state and local income taxes. For example, if your federal income-tax rate is 28 percent and your state tax rate is 8 percent, your effective tax rate is 36 percent. Also, if you are self-employed, you need to figure in FICA. This could have a net result of more than 50 percent tax savings on net income. As always, it is important to check with a CPA or tax planner about the effects of tax leasing in your business.
The key to maximizing your tax savings for your investment is being able to use the true-tax lease in combination with more traditional depreciation. To make this unique combination work, it is critical to find a lender that specializes in leases and loans.
Ronald J. Pope is district manager for Wells Fargo Financial Leasing Inc., which offers traditional loan packages as well as commercial leasing for a variety of industries, including self-storage, car washes, apartments, retail, light manufacturing, strip malls and others. For more information, call 518.359.7920; e-mail [email protected].