Last year brought big changes to U.S. tax law, due to the passage of the Tax Cuts & Jobs Act. Now that the 2018 tax year is behind us, we checked in with tax experts to find out how self-storage operators can maximize their upcoming tax deductions and make strategic decisions for 2019.
Overall, new tax laws created some potentially lucrative new write-offs for depreciation. One of the most significant changes for self-storage facility owners is an increase in bonus depreciation from 50 percent to 100 percent. In addition, bonus depreciation that previously had only been eligible for new property is now applicable to new or used property.
For example, someone who is buying an existing asset may be able to write-off a significant amount of the purchase price in the year of acquisition, notes Kevin A. Eisenhart, CPA, MBA, MST, a partner in the Tax Services Group at RKL LLP in York, PA.
However, it also is important to note that these changes are only temporary. The new 100 percent rate applies to property placed in service before January 1, 2023. The rate phases down thereafter between 2023 and 2026.
Fully deductible expenses
A second major change applies to the Section 179 Asset Expensing Election, which was increased significantly to $1 million that can now be written off. Taxpayers also can now take Section 179 deductions on certain structural components of buildings that historically were not eligible in the past, such as roofs, HVAC, fire protection and security systems.
Taxpayers can now write-off 100 percent of those costs in year-one of acquisition (subject to the limitation previously discussed), notes Eisenhart. So, if a self-storage facility installs a new alarm system, under old law that expense would have had to be written off over a longer period of time, whereas now it can be fully deducted in year one.
One caveat in utilizing Section 179 is that the business does have to show a profit. An entity can’t use Section 179 to make their loss bigger, notes George Kotridis, CPA, Principal, Real Estate at CliftonLarsonAllen LLP in Philadelphia, PA.
“That is different than bonus depreciation, which you can use even if you have a loss,” he says.
In addition, taxpayers who place in service more than $2.5 million of qualifying assets begin to phase out the amount of Section 179 they’re able to take, whereas bonus depreciation does not have any such limitation.
Section 199A business deduction
A third major change for LPs and LLCs is a business deduction via Section 199A that allows owners of these pass-through entities to deduct 20% from their pass-through income to arrive at taxable income. For taxpayers in the top federal tax bracket of 37 percent this effectively reduces their tax rate to 29.6 percent on this category of income.
“However, there are many limitations – the trickiest of which would be whether or not the income is qualified business income,” says Kotridis.
The IRS has released some guidance, but further clarity is needed, especially as it pertains to rental real estate world.
“The key here is whether the self-storage activity rises to the level of a trade or business. While direct rental to retail tenants may qualify as a trade or business, a master triple net lease to a third party operator may not,” says Kotridis.
2019 tax resolutions for self-storage owners
Broadly speaking, owners do need to work closely with their tax advisors to analyze their particular circumstances, and also stay abreast of additional guidance and clarity from the IRS that will continue to emerge not only in 2019, but likely over the next two to three years.
“This tax bill was a pretty big deal, and the challenge comes with the interpretation,” says Kotridis. “There is still quite a bit of vagueness and ambiguity in some of these concepts.”
That said, here our top recommendations for storage operators to consider in 2019:
- Perform a Cost Segregation Study to determine how much of the purchase amount can be allocated to personal property, land and improvements or other types of assets that might qualify for the 100 percent bonus depreciation for the tax year in which a property is acquired.
- Assess your entity structure to make sure it’s organized in the most advantageous way given a taxpayer’s specific situation and business plans.
- Re-examine all LP and LLC agreements, as well as any master lease agreements, to ensure that you are structured in ways that allow benefiting from the Sec199A business deduction if possible. For example, guaranteed payments to certain partners are excluded from the Section 199A 20% business deduction calculations. So, an entity may want to revise how those economic arrangements are structured.
- Assess depreciation schedules based on new tax law changes.
- Tax law changes eliminated a number of individual deductions. So, it is important to look at business and individual income holistically to come up with the most advantageous tax strategy.
- Don’t wait until year-end. Work with an accountant or tax consultant year-round to discuss strategies to maximize tax savings.