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November 8, 2022
Cost segregation is like free money! Sort of...
Utilizing self storage cost segregation is one of the reasons many operators pay for an accountant. But what exactly is this wizardry, and why does it help your business?
In this article, we’ll go over self storage depreciation, cost segregation, and how these deductions can help you improve your business and save you money on your taxes.
As a self storage operator, you’re not just maintaining your units - you’re a small business owner, with all the responsibilities that entails. Taking advantage of cost segregation on your taxes can enable you to invest in other aspects of your business, growing while your investments depreciate.
Depreciation is a term referring to the loss of value of an asset over time. All of the physical assets, your self storage units, your gate, your parking lot, and your office, will need updating periodically - meaning they aren’t holding their value forever. Your facility is worth that much less to you as it gets older and older.
Or, for another example, your gate cost you $10,000 (we’ll be using multiples of ten in this article because I’m a writer, not a mathematician). You replace it every ten years. Pretend you make $10,000 in profit every year.
Without recording depreciation, your accounting would look like you make $10,000 a year in profit - but every tenth year, when you replace your gate, you make $0.
If you do take depreciation into account, you can reframe this as making $9,000 every year, with $1,000 lost to gate costs.
Day-to-day, this may not matter much. You still have to have $10,000 on hand to replace your gate, and you still have the same amount coming in. However, accounting for depreciation helps you see exactly how much you can expect to be spending on maintaining your facility.
The big advantage of depreciation comes at tax time, with the practice of cost segregation.
While depreciation helps you frame the expenditures of doing business, using cost segregation can drastically change how much you owe in taxes each year.
Cost segregation changes the way you calculate depreciation over time. By default, your self storage facility depreciates over 39 years. That means the estimated lifespan for the whole property is 39 years, and you can claim 1/39th of the value of your facility as a loss on your taxes.
However, different parts of your facility will degrade (and depreciate) at different rates. Carpets, locks, woodwork, and certain security features all depreciate over an estimated period of 5 years.
Things like asphalt, exterior lighting, and fencing all depreciate over 15 years. These items will need to be replaced more frequently than every 39 years.
This means that by classifying your facility as one 39-year property, you’re going to be missing a lot of the depreciation.
Cost segregation separates all the different pieces of your real estate into separate depreciation categories. If you have a cost segregation study performed, you’ll be able to use that information to more accurately depict your facility’s real depreciation.
With a cost segregation study, you’ll be able to claim the depreciation of certain parts of your real estate at a much quicker rate (one closer to the rate at which you’ll actually be replacing them).
Performing a legal cost segregation study will cost you - and it’s not really something you can do yourself - but when you have all the pieces separated, you can quickly recover those costs.
Because, when you take advantage of depreciation write-offs and cost segregation, you’ll have a significant reduction in income which lowers the amount you pay in income taxes.
The reason all of this is important is that you can take the depreciation losses - which happen every year, and you will pay for them eventually - and deduct them from your income. Then, come tax season, your total income is less, so you pay less in taxes.
When you get a reduction in your owed income taxes, you have more money in your pocket - and that money can be put to use growing your business! The value of your cost segregation savings could go into your marketing budget, letting you fund pay-per-click ads, or you could even upgrade your website!
When I first learned about depreciation and cost segregation, it sounded like we were simply frontloading the deduction, but this isn’t the case. Rather than taking some of your depreciation early and not taking it later, you’re simply making your depreciation more precise.
And you’ll be able to repeat that same rate of depreciation when you replace the items.
Understanding cost segregation and depreciation can help you take advantage of the small-business benefits available in our tax system. Applying them is tricky - most operators hire the services of an accountant to handle the specifics.
We recommend hiring an accountant or tax service that is familiar with the self storage industry if possible. They can help you get the most out of your tax filings!
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