A self-storage business can be a complicated entity that might involve multiple investors, which can make tax filing a convoluted process. Whether you’re preparing for the next tax season or filing under an extension for this year, it’s important to think about potential issues as well as ways your company can benefit. Doing so will save money and, if problems are caught early, protect you from an unwanted audit.
Watch for Tax-Law Changes
While no significant 2021 tax-law changes have been announced at the time of this writing, the Biden Administration has signaled it would like to modify the U.S. tax code. There’s no guarantee this will happen, but it should be a topic of discussion with your accountant.
There’s an expectation that capital-gains tax and ordinary top-tax rates will increase this year or next. This means you need to start planning now. Speak with your bookkeeper about potentially reporting your income early in 2021 and deferring certain deductions in 2022. Proper timing and deductions can save you money if tax codes do change. There’s no one-size-fits-all solution, so this advice won’t work for everyone; but it’ll apply to many self-storage owners.
If there’s an increase in tax rates, you may want to hold off on any advanced depreciation until next year, so you can save more money down the road. Just take a regular table depreciation for now. You may also want to postpone any cost-segregation study until 2022. This tool identifies and reclassifies personal property assets to shorten depreciation time for tax purposes, in turn reducing income-tax obligations for the year. If you’re forgoing advanced depreciation in anticipation of a higher tax rate, you won’t need a cost-seg study for 2021.
Understand the Requirements of Any PPP Loan
The COVID-19 pandemic created an unprecedented amount of financial assistance for business owners, including the Paycheck Protection Program (PPP). If you accepted such a loan, as long it was used to maintain payroll and make rent or mortgage payments for your business, it’ll be forgiven and turned into a tax-free grant. However, you must understand and adhere to the terms and conditions. Not using the money correctly could lead to your business being liable for all or some of the outstanding debt.
The purpose of PPP loans was to help business owners maintain their employees and buildings during the crisis. To qualify for forgiveness, you needed to maintain your employee-compensation levels, spend at least 60% of the money on payroll, and use the rest for business rent, lease or utilities. If you didn’t use the money for these purposes, you’re required to pay back a percentage.
Understand Your Operating Agreement
It isn’t uncommon for a self-storage facility to have multiple owners. Using a variety of investors makes it easier to raise capital; and bringing in people with a variety of skills can be helpful in growing the operation. However, being part of a multi-partnered business means you must have an operating agreement, and it must match your tax filings.
Capital accounts should track the money each investor contributed as well as any undistributed preferred returns and distributions based on how you wrote them in your agreement. Self-storage owners working in a limited partnership can sometimes do a debt-finance distribution, which means the partnership secures debt, then distributes a portion of the proceeds to the owners. If you decide to do this, you might be able to deduct some of that interest, but generally not all of it.
It’s also worth noting that smaller self-storage companies are exempt from the business-interest expense limitations. This applies to any business with gross receipts of $26 million or less; however, this exception may not apply to you if you’re considered a tax shelter. This comes into play if more than 35 percent of your losses are allocated to limited partners. Know your business’s operating agreement. It’ll help you out next tax season.
Clearly State Your Intentions
What was the reason you started your self-storage business? Were you planning to run the facility yourself or hoping to sell one day or? You need to have an answer to this question, as it’ll have tax implications. Self-storage developers deal with a high tax costs because the whole process is taxed as business income. You may be OK with this, but you need to state your intentions in the tax filings.
Owners who manage their own facilities and later sell them will deal with capital-gains tax as well as deprecation recapture. This is the gain realized by the sale of depreciable capital property, which is taxed at a higher rate. The rate can be lower under a capital-gains play, but you need to make your intentions clear before you file.
This doesn’t mean you can’t change your mind about the purpose of your business. Entities in the real estate market change direction all the time. But I’ll reiterate: You must make your intention to change direction clear before you file.
It’s never too soon to start preparing for the next tax season. Be aware of potential changes to the tax code and make sure you understand the conditions of any PPP loan you received. Understand your business-operating agreement and clearly state your intentions when you file. Taking the time to get your tax issues in order early will save you time and money down the road.
Note: The information is this article is intended to be general education, not tax advice. Consult with your tax advisor to determine the best strategy for your specific facts.
Phil Wuollet is a certified public accountant and a partner at Epstein Schneider PLC, an accounting firm in Scottsdale, Arizona. He helps clients with tax compliance as well as developing forward-thinking strategies for reducing and deferring taxes. For more information, call 480.483.3024.