Taxes for Self Storage Facilities

From Bob Jennings at TaxSpeaker. Check out TaxSpeaker at taxspeaker.com

The Storage and Warehouse Leasing industry rents out and leases space for self-storage to individuals and businesses. This industry has been one of the fastest-growing sectors of commercial real estate since its inception in the 1960s. This industry is in a unique position in that it generally thrives even during poor economic conditions. For example, as people gain more disposable income, they purchase more things that then need Storage. On the other hand, a recession will force businesses to close their doors and people to downsize, creating demand for Storage of old inventory or possessions during a move.

10-by-10 storage spaces are generally the most popular. They can store enough goods to fill two complete bedrooms or three rooms, which is equal to half of a typical one-car garage. Metropolitan areas offer a high demand for storage facilities. These areas are usually highly populated and have higher levels of income. Thus, people in these areas accrue extra material possessions faster.

Competition in the industry is not just based on size/price but also on security and security systems as consumers are more likely to choose the safest, affordable facility. Computerized kiosks at storefronts, as well as websites and apps, allow customers to access their storage spaces, pay bills, control climate and more, all with a click of a button, and make the facility competitive with tech-savvy customers.  Vacancy and bad debt rates in the industry average about 20%.

Self-storage unit operators are operating non-residential rentals of commercial real estate property. Because they provide no substantial services, the income is passive income and subject to the 3.8% NII surtax if their AGI is above the threshold. Self-storage activities do qualify for the §199A 20% QBI deduction as a passive trade or business. Any income is passive and exempt from self-employment tax under §1402(a)(1) but may offset passive losses.

In 1990’s Hopper v. Commissioner, 94 T.C. 542, the U.S. Tax Court considered a case where an attorney owned two self-storage facilities and determined the activity was a rental real estate activity, and also said any ancillary income, such as providing a soft drink machine, pest control, contents insurance, and the sale of locks, packing materials, and pallets were provided for the convenience of the tenants and were minor and incidental; thus, all income was passive rental real estate income. 

Self-storage activities operated by individuals and disregarded SMLLCs will be reported on Schedule E, and on Form 8825 for flow-through entities. Because the provision of services determines whether the activity is a trade or business, or real estate rental, the court in the above Hopper case also stated (emphasis added by court) “THE FURNISHING OF HEAT AND LIGHT, THE CLEANING OF PUBLIC ENTRANCES, EXITS, STAIRWAYS AND LOBBIES, THE COLLECTION OF TRASH, AND SO FORTH, ARE NOT CONSIDERED SERVICES RENDERED TO THE OCCUPANT... We see no distinction between the nature of these services and those such as cleaning, sweeping, painting, and other general maintenance and grounds work which were provided.”

Normally, the buildings themselves are 39-year life commercial buildings. Because self-storage facilities are composed of many shorter-life assets, operators should carefully allocate construction costs, or if purchasing, purchase price. Existing operators may greatly benefit from cost segregation studies.

Here are the depreciation life reminders. Remember, items in the 3-10 year categories qualify for §179, 3-20 year categories for qualify for bonus depreciation, and a few other special categories such as qualified improvement property (QIP) and qualified real property (QRE) (roofs, HVAC, sprinklers) qualify for §179 as well.

Building                                               39 years

A/C or heat                                          39 years, but qualifies for 179 as QRE

Sprinklers & fire systems                      39 years, but qualifies for 179 as QRE

Interior remodeling                                15 years, qualifies for 179 and bonus as QIP

Fences & gates                                    15 years, qualifies for bonus

Landscaping                                        15 years, qualifies for bonus

Parking lot, roads                                 15 years, qualifies for bonus

Portable, movable storage units              7 years, qualifies for 179 and bonus

Cameras, computer systems                 5 years, qualifies for 179 and bonus

Gate motors and arms                           5 years, qualifies for 179 and bonus

Check-in kiosk                                      5 or 7 years, qualifies for 179 and bonus

Operating Statistics

Published IRS data from 2019 reveals that about 60,000 self-storage operators in 2019 operated as sole proprietorships. We presume (and hope!) that the majority of these are disregarded single member LLCs (SMLLCs).

Average annual revenue per operator $51,000

Average expenses per operator   $50,000

Expense percentage per operator:

Material Costs (locks, boxes, pallets)       14%

Depreciation                                 14%

Other business expenses                 14%

Interest Expenses                               9%

Repairs                                            8%

Taxes paid                                     7%

Car and truck expenses                  6%

Utilities                                     5%

Contract labor                               3%

Salaries and wages                          3%

Determining Facility Rates of Return (Cap Rate)

Cap Rate = (Net Operating Income)/(Current FMV)

For example, if a facility is for sale on the market for $2,000,000 and has a NOI of $100,000, the Cap Rate is $100,000/$2,000,000 = 5%.  Meaning if a taxpayer paid $2,000,000 for the facility in cash, he or she would expect to get a 5% return in annual cash flow for the $2,000,000 investment.

If the taxpayer is the facility owner and wants to get a sense of what the property might be worth, he or she would take the NOI and divide it by the going cap rates for the area and the quality of the facility.  For example, if NOI is $100,000 for a 30-year-old facility in a rural market, the cap rate might be 10% vs. 4% for a new class A facility in Manhattan.  The  facility in this example might be worth $1,000,000 ($100,000/10%).‍