01/02/2018
Interested in Increasing Cash Flow?
By Jeffrey Hobbs
President, Segregation Holding, & AZSA Member
Cost segregation benefits self-storage facilities by increasing cash flow through accelerated depreciation (see case study: Cost Segregation Mini-Storage Messenger).
Cost segregation is not new. It has been in existence since 1954 when the IRS allowed for certain personal assets to be accelerated into a shorter life class. However, it wasn’t until Hospital Corporation of America sued the IRS in 1997 and won that the IRS revisited the issue of accelerated depreciation. Subsequently, after the Tax Act of 2004, the IRS’ chief counsel issued a memo stating that “…cost segregation, for it to be properly applied, had to involve those with competencies in architecture, engineering or construction and/or construction techniques, in order for personal property assets to be accurately identified and segregated.”
There have been many court rulings and challenges since the IRS acquiesced to the HCA suit. Cost segregation has stood the test of time and challenge. Cost segregation is the only accepted and IRS-approved method of reclassifying assets. Utilizing an engineering-based study assures a self-storage owner of getting the maximum benefit allowable.
Cost segregation is a helpful tool for both climate-controlled and non-climate-controlled facilities. However, climate-controlled self-storage facilities are more expensive to build and operate. They allow for a wider variety of storage options where special conditions are required, say for computer equipment or books and photographs. It is this type facility where cost segregation can often uncover as much as 85% qualifying tangible personal property. Tangible personal property is considered a 5-year asset under IRC Sec. 1245. Real property is considered IRC Sec. 1250 property that is depreciated over 39-years. Some qualifying assets under IRC Sec. 1245 include specialty electrical systems & HVAC, security system, fencing, solar/wind systems, landscaping, and much more. These assets qualify for accelerated depreciation under MACRS. MACRS is Modified Accelerated Cost Recovery System and is the method of depreciation IRS requires for self-storage facilities.
Non-climate-controlled self-storage facilities typically realize upwards to 65% qualifying tangible personal property, so both types of self-storage facilities benefit greatly when cost segregation is applied.
The self-storage real estate market has drastically changed over the past decade. Owners and investors looking to acquire a self-storage facility are increasingly savvy in the buying process, including due diligence, cap rates, appraisals, and methods for determining property value. Cost segregation delivers here again. When cost segregation is applied, the owner receives a detailed cost segregation study report. This report itemizes all building components used in construction; thus, it is vital in confirming an accurate appraisal. This cost segregation report will justify a lower real estate tax bill. Tangible personal property is taxed at a lower rate than real property. This report will also justify a lower property insurance premium. Tangible personal property costs less “per thousand” of property value to insure over real property. It also comes in handy in case of fire or theft because the report accurately identifies all building components for the insurance adjustor. This makes it easy to prove asset values and thus, determine qualifying losses for compensation. Cost segregation is an integral component in acquiring – and operating – a self-storage facility.
In summary, cost segregation benefits self-storage facilities in many ways: it
- Identifies all building components qualifying for accelerated depreciation;
- Is basis for accurate appraisal;
- Lowers real estate tax bill;
- Lowers property insurance premium;
- Ensures accurate identification of assets in case of fire or theft;
- Delivers cash in the critical first five years of self-storage business ownership;
- Is a vital tool that any self-storage owner should take advantage of today.
Cost segregation is also a vital a tool for investors considering self-storage. The first five years of ownership is always the toughest. Cost segregation puts more cash in the hands of the owners, and their investors, than any other business tool…guaranteed!
Author: Jeffrey Hobbs is the President of Segregation Holding, one of the nation's leading forensic cost segregation firms. You can reach Jeff at 972-897-8019.