Money-Saving Tax Opportunities for Self-Storage Owners: How to Benefit From Asset Depreciation

No matter which asset class a real estate owner or investor is involved with, the goals are generally the same: to maximize cash flow, decrease expenses, increase value and redeploy capital. One expense that’s always troubling is income tax.

The good news is there’s a general strategy that can help you save money in this area: depreciation. It’s an approach that should be discussed with a qualified CPA and cost-segregation expert; however, reviewing your short- and long-term tax plans is an excellent way to support the financial health of your self-storage business.

What Is Depreciation?

Depreciation is the decrease in value of a property over time due to wear, tear and aging. It’s also an accounting practice used to spread the cost of a physical asset over its useful life, according to Investopedia. Per the U.S. tax-depreciation system known as the Modified Accelerated Cost Recovery System, commercial properties like self-storage facilities are depreciated over a schedule of 39 years. This applies to the real estate itself, but there are strategies that allow you to depreciate certain equipment and components at a faster rate.

For decades, the IRS has permitted “component depreciation,” which has developed into what’s currently known as “cost segregation,” for properties that generate income. Components that are required to achieve Certificate of Occupancy (C of O), such as the core and shell of the building, primary lighting required under building codes, and other life-safety items generally fall under the category “real property,” which is depreciated as 39-year, straight-line property over 40 tax years.

Other items may be depreciated as personal property. These are components of the building or improved land that support business activities but aren’t required to obtain the C of O. Examples from inside your self-storage management office might include countertops, flooring, cabinetry, millwork, trim, phone lines, internet and cable. These can be depreciated over five years. Outside the building, qualified land improvements are depreciated as 15-year property. Examples are fencing, gates, walkways, pavers, landscaping, retaining walls, drainage, retention/detention ponds, bollards, lighting and signage.

It isn’t unusual for a self-storage facility to qualify for 8% to 12% of the cost basis or purchase price as five-year personal property and an additional 8% to 12% as 15-year qualified land improvement. In other words, if the property is worth $1 million as constructed or purchased, less the land value, the owner may be able to accelerate $160,000 to $240,000 in depreciation. And this is helpful, as the larger the depreciation expense, the lower your taxable income and the less you pay in taxes.

Bonus Depreciation

According to Investopedia, bonus depreciation is an accelerated method that allows a taxpayer to deduct 100% of depreciation upfront on their federal tax return. If you use it, your company may pay substantially lower taxes in the tax year in which you claim it.

With bonus depreciation, any qualified personal property with a 20-year class life or less is eligible for a full percentage deduction under the accelerated-depreciation rules. For tax year 2023, 80% bonus depreciation was available. If we were to do a cost-segregation study on the $1 million self-storage facility mentioned above, we’d be permitted to accelerate 80% of the $160,000 to $240,000 of the depreciation. At a 37% tax rate, that would create $59,200 to $88,800 in additional cash flow for the 2023 tax year.

In this case, we’re front-loading the depreciation, taking a big chunk. The tradeoff is we’re going to get much less over the next 39 tax years. It’s about timing. What’s important to understand is this is a cash-flow and “time value of money” strategy that creates a massive amount of wealth in the real estate market.

Potential Opportunities

On Jan. 31, the House of Representatives passed the Tax Relief for American Families and Workers Act of 2024 (HR 7024) with 83% bipartisan support. It now needs to get through the Senate and is expected to do so by early August.

This legislation retroactively extends 100% bonus depreciation for tax years 2023, 2024, 2025 and 2026. This is a huge opportunity for real estate owners, investors, architects, engineering firms and all trades of commercial construction. It won’t only encourage new development as well as facility expansions and renovations, it’ll foster more acquisitions of existing real estate.

To meet the requirements for bonus depreciation under HB 7024, any qualified personal property must be 20 years old or less, and it must have been constructed or purchased between Sept. 27, 2017, and Dec. 31, 2026. If a self-storage asset meets those two criteria, the owner can enjoy tax advantages.

In fact, you may even claim bonus depreciation on a current-year tax return without having to amend any prior year’s return. You simply need to file IRS Form 3115, which is a preapproved accounting-method change. This lets the IRS know that you’ve switched from 39-year, straight-line depreciation to five-, seven-, 15- and 39-year class lives. It permits a one-year catchup of the accelerated depreciation on the current tax year.

The takeaway is there are two tax codes in this country: one for the informed and the other for the ignorant. Keep yourself educated by working with a tax or cost-segregation expert to realize savings for your self-storage business.

Mike D’Alessandro is managing director for Research Tax Credits LLC, which offers cost-segregation services. He works closely with CPAs and attorneys as well as financial, banking and real estate professionals to help identify opportunities for tax savings. To reach him, call 484.232.1076 or email [email protected].

Matt Junkin has been working in commercial real estate since 2010. He’s an investment associate with The Bledsoe Self Storage Group of Marcus & Millichap, a commercial real estate investment services firm with offices throughout Canada and the United States. He works closely with his clients’ partners, financial advisors, accountants and attorneys to develop and follow a tailored real estate investment strategy. For more information, call 717.808.1192 or email [email protected].