More Money in Your Pocket: Leveraging the U.S. Tax Code to Improve Self-Storage Cash Flow

One of the great things about being a self-storage owner is there are many ways to use the current tax code to generate additional cash flow and reduce expenses. You may already be familiar with the benefits you can enjoy when renovating or improving an existing facility, but you may not be aware that there are also advantages to tearing something out and throwing it away. Understanding the tax-saving strategies available to you can help you put more money in your pocket and keep it there.

Suppose you won the lottery. Would you want to receive your payout in a lump-sum or in annual installments over 40 years? Most businesspeople would say, “Give me the money! I know how to invest it better than the government or anyone else.” It makes sense to let your money work for you and your business rather than for the IRS.

Let’s explore tools like cost segregation, bonus depreciation and asset disposition and what they can do for your self-storage business. The reality is, for every $1 million in facility costs, you’re looking at potential tax savings of nearly $100,000. Don’t leave money on the table. Put it to work for yourself!

Cost Segregation

You can depreciate your self-storage facility in one of two ways. The first is the default straight-line method that allows you to depreciate a building equally each year for 39 years. This means you can apply 1/39th of the cost of your building to offset your annual income. The second method is accelerated depreciation, also known as cost segregation. This tax strategy uses additional depreciation over a shorter time period to help reduce your federal-tax burden and generate additional cash flow.

The assets of a self-storage building can be categorized into various buckets, each with its own depreciation value. Depending on the type of structure, you can allocate 20% to 40% of the total value into 5-, 7-, or 15-year time periods instead of using the standard 39 years. Items that fit into the 5-year bucket include interior doors, specialty electrical or plumbing systems, and hallway skins. Assets that fall into the 15-year bucket include exterior items like the parking lot, fencing and landscaping.

Bonus Depreciation

An added tax benefit that’s in play is bonus depreciation, which allows you to immediately deduct a large percentage of the purchase price of your eligible self-storage assets. You may be able to depreciate assets with shorter lifespans within the first year or two. Depending on when you bought or built the facility, you may be able to deduct up to 100% of its constituent parts.

From September 27, 2017, through Dec. 31, 2022, the bonus depreciation rate was 100%. Starting in 2023 to when it expires in 2027, it’s decreasing 20% per year. If you buy, build or renovate a property this year, you’re allowed bonus depreciation of 60%. That means you can deduct 60% of everything eligible for acceleration. If you bought a property in 2018 when the bonus was 100% and you haven’t yet accelerated the depreciation on it, you can still do so on your current tax return and get the benefit of those tax savings. Best of all, you don’t have to amend prior tax returns.

Let’s look at another example. If you bought a $3 million self-storage facility in 2023, depreciating it using the straight-line method would provide you with a deduction large enough to offset income up to a little more than $75,000. At the 37% tax bracket, you could eliminate $27,750 in taxes.

If you were to instead apply a cost-segregation study with bonus depreciation, you could receive a deduction of $900,000, or $333,000 in tax savings. Then, you could take that $333,000 you didn’t pay to the IRS and renovate your newly purchased facility. This would enable you to increase your rental rates and boost net operating income, which increases the overall value of the property.

You could also use those savings to acquire another facility and grow your portfolio. Thinking back to our lottery scenario, you just took a lump sum of cash flow out of your asset that would’ve otherwise gone to Uncle Sam and instead invested it to make more money!

Additional Tax Strategies

There are numerous other tax opportunities you can use anytime you buy, build, renovate or make an improvement to a self-storage facility. For example, when you remove something that still has life for future tax deductions and throw it out, that item may qualify as a disposition. The IRS allows you to write off the remaining depreciable basis of that asset at the time you dispose of it.

For example, lighting is categorized as a 39-year asset from the time you bought the facility. If you replace the current lighting with new LED fixtures and have owned the building for 10 years by that point, you will still have 29 years of tax life remaining, making those years eligible for disposition. You can also apply bonus depreciation to the new lights that were installed under QIP (qualified improvement property).

Applying this principle to LED energy projects sometimes leads to net-zero cost due to all the tax savings. The same concept could apply to many other items like self-storage unit doors, a parking lot or a roof replacement.

Grab That Cash!

Every self-storage owner should consider using these tax-saving strategies. If you’re planning a facility renovation or improvement, investigate how you can benefit from cost segregation, bonus depreciation and other tactics.

Ask an expert about the necessary timing and specific criteria. A reputable cost-segregation company, teamed with a well-informed tax preparer, can make navigating compliance issues and maximizing deductions relatively easy for you. Your cost-segregation specialist can also work closely with your accountant or tax preparer to maximize deductions while helping you maintain compliance with current tax codes.

Stop leaving cash on the table! Follow up and educate yourself further on how to use the U.S. tax code to maximize the cash flow that can be pulled out of your self-storage assets and put it to work for you.

Warren Dazzio is executive vice president of Baton Rouge, Louisiana-based Cost Segregation Services LLC, an engineering-based consulting firm specializing in the U.S. tax code. The company offers cost-segregation services, 179D energy-efficiency deductions, research and development credits, and other tax strategies. Warren speaks nationally at self-storage conferences and Certified Public Accountant events. To reach him, call 225.241.9823; email [email protected].