The 2017 Tax Cuts and Jobs Act has brought about major reform in the tax laws impacting self-storage operations and other commercial businesses. Couple that with the 2014 Tangible Property Regulations (TPRs), which were designed to give guidance on what an owner is required to capitalize and what he can expense, and all building owners have the ability to capture $30,000 to $80,000 in income-tax savings in the first year of ownership.
Though the new tax codes have some limits, they provide more opportunities to expense items and offer beneficial depreciation deductions. Let’s explore how to exploit the benefits of reform and lower or defer income taxes to create additional cash flow.
The first thing you should do is apply one of the three safe harbors to your situation. These allow you to expense certain items right off the bat. They include:
- De minimis safe harbor: Your CPA will know about this. It allows most business owners to expense anything costing $2,500 or less.
- Routine maintenance safe harbor: This is one of the least used but has an incredible benefit. It allows you to expense a repair to a building if you reasonably expect to replace it within a 10-year timeframe. How does that apply? Think about carpeting, cabinetry and painting, for example.
- Small taxpayer safe harbor: This is a bit complicated but worth looking into if your facility has multiple buildings.
Second, identify the value of building systems and structural components. The tax codes give very specific guidelines on whether expenditures should be capitalized as an “improvement” or expensed as a “repair.”
For example, let’s say you have an HVAC system worth $100,000. It includes the interior and exterior HVAC units, ductwork, wiring, etc. One of these units goes bad and must be replaced. You can spend up to $35,000 fixing it and still expense the dollar amount because that building system was already defined. If you spend $40,000, you’d have to capitalize the expenditure as an improvement. How would you know this without a building-systems definition? A reputable cost-segregation firm can provide this for you.
The new regulations also allow building owners to “look back” and expense large deductions in the current year by applying the regulations to prior years. Best of all, none of these strategies require an amended return.
Explore Cost Segregation and Accelerated Depreciation
Once you maximize your expenses, it’s time to consider how depreciation can help you save on or defer taxes. The U.S. tax code allows owners to depreciate their property in two ways.
Straight-line depreciation slowly depreciates the whole building over 39 years. It basically allows commercial building owners 1/39th of the cost of the building to offset income every year for 39 years.
To break a building into various parts and accelerate depreciation into shorter tax lives (most commonly five, seven and 15 years), you need an engineering-based, cost-segregation study. This creates a larger amount of depreciation in the first five years of ownership that offsets business revenue and immediately lowers income taxes. Tax reform gives you the ability to capture all of this savings in the first year of ownership. You’re looking at $30,000 to $80,000 in additional cash flow per $1 million in building costs, which you can use to gain interest and invest back into your business.
In the case of new construction or additions, a cost-segregation study will identify items that qualify for Section 179 and 100 percent bonus depreciation, allowing for a significant amount of extra depreciation. In other words, rather than spread depreciation over multiple years, deductions are all available in the first year of ownership. This allows an owner to take anywhere from 20 percent to 40 percent of the value of a building as a deduction in that first year.
Self-storage buildings can particularly benefit from cost segregation and bonus depreciation. Items like interior doors, moveable wall partitions, security systems, specialty lighting, landscaping and paving are all items that can be accelerated.
Use Partial Asset Disposition
If you’ve renovated or remodeled in 2019, a partial asset disposition (PAD) allows you to write down the basis of assets that were removed as well as the labor costs to remove and dispose of them. Typically, owners capitalize an entire renovation when some portion of the project can often be expensed.
A PAD allows you to receive a tax deduction in the same tax year as the renovation, but it’s a “use it or lose it” opportunity. If you fail to capture a PAD in the current tax year, the opportunity is lost forever. This is a true tax savings and not a deferment, as it results in a tax savings at the time of sale.
A reputable cost-segregation company, teamed with a well-informed certified public accountant (CPA), can make navigating compliance issues and maximizing deductions relatively easy for you. The right firm will perform a site survey of each building, back up its work with proper documentation and defend the work at no cost to the client should an audit ever occur. A good firm will also work closely with your CPA or tax preparer to maximize deductions while helping you maintain compliance with current tax codes. Honestly, informed building owners have used these strategies for years, but now you can, too.
Warren Dazzio is executive vice president of Cost Segregation Services Inc., an engineering-based consulting firm specializing in the U.S. tax code as well as cost-segregation and R&D studies in the United States. He has extensive knowledge of operations, sales and business development in multiple industries. For more information, call 225.241.9823, e-mail [email protected]; visit www.cssistudy.com.