President Donald Trump recently signed a tax-reform bill into law that provides the most significant U.S. tax changes since the Tax Reform Act of 1989. While self-storage owners will continue to enjoy many of their previous tax-relief advantages, some significant changes could affect their situation. This article highlights some of the key opportunities and modifications of the new law to help you stay informed.
Self-storage owners often use 1031 exchanges when selling their assets to defer certain tax liabities. This strategy can greatly help investors grow their assets in the long term. Moving forward, they’ll continue to benefit from similar transactions. This new law limits 1031 exchanges to real property, referred to as real estate. In turn, this means exchanges of personal property, collectibles, aircraft, franchise rights, rental cars, trucks, heavy equipment and machinery, among others, will no longer be permitted for the 2018 tax year.
The new tax law allows self-storage owners to deduct interest on their real estate loans. Those who choose to claim this deduction will now have to increase the depreciation period for their assets. If you do claim the mortgage-interest deduction, the depreciation schedule for commercial properties increases from 39 to 40 years. If you don’t take the deduction, the depreciation period remains unchanged from the current 27.5-year schedule. You may still elect to perform a cost-segregation survey to carve out and accelerate five-year and 15-year properties.
The new law also includes provisions for bonus depreciation of capital expenditures, which would allow you to fully expense certain items. Section 179 of the new law provides the opportunity to expense up to $1 million for business assets, including furnishing, HVAC, roofing and security systems for nonresidential properties. The deduction phases out after $2.5 million.
Longer depreciation schedules can have a negative impact on the return on investment. Owners will need to consider these longer schedules if they elect to use the new exception to the interest limit. The self-storage industry is among the niche real estate segments that Section 179’s depreciation rules will favor.
Those of you structuring your holdings via pass-through entities such as limited-liability companies (LLCs) will receive a 20 percent deduction on qualified income. This applies only at the entity level. Furthermore, it can only be applied to a property held at the end of a taxable year. Income from trusts, estates and real estate investment trust dividends are also eligible.
Another boon for owners at the holding entity level can be witnessed in the reduction of the maximum tax rate from 35 percent to 21 percent. Some of these provisions will be phased out within the next five years.
Individual Tax Rates
The new tax law also has provisions dealing with individual tax rates. The total number of brackets remains unchanged at seven; however, the income span for each has been modified, while marginal tax rates have been reduced, which has nearly doubled the standard deduction for single and married filers. On the estate-planning side, the tax law doubles the exclusions for single filers as well as married couples to $11 million and $22 million for estate taxes, respectively.
An important change for more active investors who may make opportunistic sales or flip a property has also occurred. Those looking for capital-gains treatment of their assets will see the required hold period increase from a year and a day to three years. This will certainly change the business model for some investors who look for quick-turnaround, value-add opportunities. This change could slow the quantity of sellers as developers choose to hold assets for longer periods rather than sell at Certificate of Occupancy or during lease-up.
While the capital-gains hold period may slow some sales, the newly introduced, 20 percent deduction on income from pass-through entities could invigorate self-storage investments—and real estate in general. On an after-tax basis, the yields offered by the sector will be even more compelling than under previous tax structures. New capital could enter commercial real estate through syndicators and investment funds that are structured to capitalize on the pass-through advantages; but some new self-storage investors will enter the market with direct acquisitions. The additional capital will undoubtedly flow across a variety of property types, including self-storage.
Overall, there are many advantages available to self-storage owners to help minimize their tax burdens. Whether they continue to apply deduction on interest and depreciation or employ the benefits of pass-through income from LLCs, these opportunities present considerable to save money over the lifetime of ownership.
Michael Mele is senior managing director of investments for Marcus & Millichap, a commercial property-investment firm. Over the past six quarters, he and his team have helped their clients close 71 transactions in 19 states, totaling more than $560 million. Since joining the company in 1999, he’s closed more than 300 self-storage transactions and has a national client list of 3,500-plus investors. For more information call 206.826.5700; visit www.marcusmillichap.com.