How to Maximize Cost Segregation Benefits for Self Storage Investors

3 min read

What is Cost Segregation?

Cost segregation is a tax planning tool that allows real estate investors to accelerate depreciation deductions on their properties.

By reclassifying certain building components and land improvements into shorter class lives, you can reduce your tax liability in the early years of owning a property. This strategy can help you increase your cash flow and reinvest those savings into further growth opportunities.

Self Storage Property Class Lives

In cost segregation, building components are reclassified into different class lives for depreciation purposes. These class lives determine the time period for when the assets can be depreciated:
  • 5-Year Class Life:
    This applies to non-structural components of the building. Examples include access control, security systems, and exterior lighting for non-climate controlled buildings. Examples include interior storage unit partitions, moldings, wall coverings, and specialty plumbing for higher-end climate-controlled buildings. These assets have the shortest depreciation period, allowing for faster tax benefits.
  • 15-Year Class Life:
    This applies to land improvements. Examples include fencing, landscaping, irrigation, and storm drainage systems for non-climate controlled buildings. Examples include loading area concrete, parking lots, and sidewalks for higher-end climate-controlled buildings. These assets also benefit from accelerated depreciation compared to the standard building structure.
  • 39-Year Class Life:
    This applies to the primary structure of commercial buildings. Examples include roofing systems, gutter systems, and flooring for non-climate controlled buildings. Examples include foundations, HVAC, electrical, and doors & frames for higher-end climate-controlled buildings. This longer depreciation period is standard for buildings not reclassified into shorter-lived categories.
The allocation of percentages to these class lives depends on the type of property. There is a sliding scale of the typical percent allocations as you go from Class A to Class D:
  • Class A Buildings:
    High-end properties with significant customization and unique features. Typically, we can assign a larger percentage of components to 5-year and 15-year class lives, significantly reducing the tax liability.
  • Class B Buildings:
    Standard properties with a mix of regular and customized features. A decent percentage of components can be reclassified to shorter class lives.
  • Class C Buildings:
    Basic properties with standard features. A slightly lower percentage of components may qualify for 5-year and 15-year class lives, resulting in less accelerated depreciation.
  • Class D Buildings:
    Low-end properties with minimal customization. Similar to Class C, these properties do not benefit as much as Class A and B properties.

Modeling vs Detailed Study

When it comes to implementing cost segregation, there are two primary approaches: Modeling and Detailed Studies. Here's a closer look at each:
Modeling Study
  • Assessment:
    No on-site visit is required
  • Streamlined Process:
    Leverage existing templates and cost estimates
  • Fast and Affordable:
    Average 2-4 weeks and $950 per study
  • Ideal for:
    Basic Class C & D buildings
Modeling studies are a great option for investors with smaller, less complex properties. They offer a quick and cost-effective way to reap the benefits of cost segregation without the need for extensive analysis.
Detailed Study
  • Assessment:
    Virtual or on-site visit is required
  • Nuanced Process:
    Every component of the building is reviewed in detail
  • Slow and More Expensive:
    Average 4-6 weeks and $4k-$10k per study
  • Ideal for:
    Advanced Class A & B buildings
Detailed studies are perfect for larger, more complex properties where a comprehensive analysis can uncover significant tax savings. While they require a higher upfront investment, the potential benefits often outweigh the costs.

Bonus Depreciation Phase Out

The Tax Cuts and Jobs Act of 2017 introduced a temporary 100% bonus depreciation for qualifying properties.

However, this benefit is in the process of phasing out. Starting in 2023, bonus depreciation decreases by 20% each year, slowly reducing the tax benefits for investors. This incentivizes investors to accelerate construction timelines to maximize these benefits.

If you have an older property and have not done a cost segregation study yet, you are in luck. By completing IRS Form 3115, you can "catch up" on your previous depreciation deductions. It's also important to keep an eye on regulatory updates, as changes to this phase out and cost segregation benefits as a whole could occur depending on the election cycle.

Curious if your property qualifies for cost seg?

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