How to Structure a Self-Storage Acquisition: 4 Ways to Maximize Your Tax Benefits and Cash Flow

By Joe DeSantis

The most important negotiating point in the purchase a self-storage facility isn’t just the price of the property but the structure of the acquisition. A proper structure will provide the new owner with the maximum tax benefit and cash flow. The structure needs to be outlined in the closing document and must include a value for each of the following categories:

• Land
• Building/improvement
• Furniture/fixtures/equipment (FFE)
• Goodwill/intangible

Let’s take a look at each category and how to determine the value for each. First, we must review the total cost to be capitalized.

Capitalized Costs

The starting point for the transaction isn’t the just the selling price; it includes other costs that were facilitative to the acquisition. The IRS recently released tangible property regulations (TPR), which provide guidance as to what gets capitalized. For example, investigation costs generally aren’t facilitative; but typically, all costs after an initial bid has been submitted are facilitative and must be capitalized.

Costs that are inherently facilitative and must be capitalized for a self-storage acquisition are:

• Appraisals
• Legal fees to negotiate terms and structure
• Document preparation that effectuates the acquisition
• Tax advice
• Title exam/evaluation
• Conveying property (transfer tax)
• Finder’s fees
• Environmental/engineering services
• Inspection services
• Regulatory and permit fees
• Application fees

The 4 Categories

Now, let’s take a look at the four categories mentioned above and how to determine the value for each.

Land. This isn’t depreciable. To determine what the land value should be, look for guidance from the tax assessment or appraisal.

Building/improvement. This is 39-year depreciable. To determine its value, look for guidance from the tax assessment or appraisal. The language to be included in the closing document should be that the new owner may do a cost-segregation study. This will break down the building/improvement into five-, seven-, 15- and 39-year components to accelerate the depreciation and provide an immediate tax benefit.

FFE. This is five-year depreciable if listed as a lump sum. However, if you have an itemized list of FFE, you can add values on each item and direct your attorney on how to incorporate this into the closing documents. This methodology is new due to the TPR. The entire list may be expensed on day one after the acquisition if done this way. Also, you’ll get a tax benefit when you sell the property since you won’t pay depreciation recapture (25 percent) on the FFE because it was expensed.

Goodwill/intangible. This is amortized at 15 years. Most lawyers and accountants are unaware of Section 197 goodwill/intangible for self-storage acquisitions. This is a huge tax benefit to a buyer. It’s basically the difference between the selling price and the value of the fixed-tangible assets. A person experienced in business valuations and transactions can assist you in determining the value. Section 197 includes:

• Goodwill
• Going concern value
• Workforce in place
• Books/records
• Operating systems
• Current/prospective customer lists
• Patent
• Copyright
• Formula
• Process
• Design
• Customer- and supplier-based intangible
• License granted by governmental agency
• Covenant not to compete
• Franchise
• Trademark or trade name

Recommended Structure

A recent self-storage acquisition I worked on had the following structure:

Because of the structure, the property-tax implications were minimized. The tax assessor only looked at the $3.6 million for land and building/improvement, not the $5 million total. Therefore, the new owner has an argument for the property taxes to stay the same or even be lowered. If this structure hadn’t been put in place at closing, he would have a tough time convincing the tax assessor not to increase his tax assessment, which would translate to higher property taxes.

If we had structured the deal with a standard structure of land at $1 million and building/improvement at $4 million, the one-year tax benefit (with assumed 40 percent total tax rate) would look like this:

By structuring the purchase under the recommended structure, it reduces taxes by an additional $64,000 in year one alone! Also, the seller will reduce the amount of property-transfer tax to be paid as goodwill, and FFE isn’t part of the property-transfer tax calculation.

Implementing the Strategy

To implement this tax-saving strategy, you need two specialized people: an attorney and an appraiser. Hiring an attorney who’ll represent you at closing is the most important decision you can make when acquiring a storage facility. Look for someone experienced in business transactions. He can negotiate more effectively for you, as he’s knowledgeable in the tax implications more so than a real estate attorney. Your attorney will be able to negotiate the recommended structure of the deal on your behalf. The structure can be used for federal and state tax purposes with the proper filing of Form 8594.

The property appraisal should be based on sound principals and match the structure in the closing document. If the document or negotiated structure deviates from the appraisal, they may not be used in challenging property taxes. In other words, you need corroborating evidence if you’re going to challenge property taxes, as the closing document in and of itself isn’t sufficient. There was a case in Ohio, St. Bernard Self Storage v. Hamilton County, which disallowed the structure in the closing document for this reason.

When purchasing a self-storage property, there’s much more to consider than simply the price. Crafting a proper structure—and adding it to the closing documents—can provide a new owner with significant tax benefits.

Joe DeSantis is president of Carrara Business Services, which provides cost-segregation services, energy solutions and tax consulting to the self-storage industry. For more information, call 800.785.1018; e-mail [email protected].