Submitted to Investment Real Estate by Johnathon W. Heller, CPA, Manager in the Tax Services Group of RKL LLP
Imagine that you’re buying or selling a self storage facility. You’ve agreed on the price, the bank is ready to close the deal and the attorneys have agreed to the liability language. Everything is wrapped up, right? Think again.
While the economics of the deal may be agreed to, there is one piece of negotiation that should be done for every transaction: allocating the sales price. Sales price allocation is extremely important for both the buyer and seller, since it will dictate tax burden to the seller and future deductions to the buyer.
For the self storage industry, items typically allocated in sales prices include land, land improvements, buildings, goodwill (intangibles created from the business operating) and equipment. At first glance, the allocations to each category may seem immaterial and any agreement should work. As noted below, however, impact to the buyer and seller are significant and tend to work in the opposite direction for each party.
Sales Price Allocation Impact on Seller
For a self storage seller, allocating the sales price to various categories has the following impact:
The allocation to land will create either a gain, in the event the land allocation is higher than when it was acquired, or a loss if the allocation is lower than when acquired. Since land is a non-depreciable asset, any gain or loss would be treated as a long-term gain or loss, if held for more than one year, and taxed at preferential tax brackets. If held less than one year, the gain or loss would be treated as short-term.
- Land Improvements, Buildings and Equipment:
Any gains derived from allocated sales prices are taxed differently. In most cases, proceeds are first taxed as ordinary income according to depreciation recapture rules. After depreciation is recaptured as income, any additional gain would be taxed as long-term capital gains (for holding periods in excess of one year). This concept is true for depreciable property.
As an intangible asset created by the value of the property’s income stream, goodwill is a capital asset and typically is taxed as a capital gain.
As it relates to the taxability of the sale from the seller’s perspective, the higher the allocation of the sales price to items generating capital gains (land and goodwill), as opposed to assets involving depreciation recapture, the better. Capital gains treatment is typically better than ordinary income for tax purposes, which keeps more of the sales price in the seller’s pocket.
Sales Price Allocation Impact on Buyer
For a self storage buyer, the goal of the price allocation is different, as the buyer is not concerned about tax due from the sales transaction. Instead, buyers are more concerned about deductions of the acquisition of the property or business:
This is not a depreciable asset for buyers; therefore, any allocation to land is non-deductible for the buyer in future years. Instead, the amount allocated to land would reduce future capital gains when the buyer looks to sell the property.
- Land Improvements, Buildings and Equipment:
Amounts allocated to these classes of property can be depreciated, over the appropriate depreciable life, turning the purchase price into a deduction for tax purposes. Under tax reform, deductions for assets with less than a 20-year life span can be accelerated due to expanded bonus depreciation rules and its availability to used property. Furthermore, cost segregation studies can be done to allocated prices for buildings and land improvements to more beneficial depreciable life spans, increasing the potential benefit of bonus depreciation.
For tax purposes, goodwill is able to be deducted, via amortization, over 15 years. While amortization cannot be accelerated like depreciation, it tends to be a good middle ground for negotiating sales price allocations as there is a benefit for both sides.
A combined benefit for both the buyer and seller, purchase price allocated to equipment and goodwill will reduce the real estate transfer tax paid at closing.
As you can see, allocating the sales price of a self storage transaction impacts the economics for both the buyer and seller. Once a price is determined, both parties should examine proper sales price allocations for their situation and add it to the negotiation table if need be. RKL’s team of tax professionals focused on real estate have decades of experience helping self storage professionals construct tax-advantaged transactions and uncover opportunities for savings.
If you have questions about self storage sales price allocations and would like more information, you can visit RKL’s website to put RKL’s industry expertise to work for your self storage facility.
About the author:
Johnathon W. Heller, CPA, is a Manager in the Tax Services Group of RKL LLP. John primarily serves small to middle market privately held companies in the healthcare and construction industries. His areas of expertise include tax consulting, compliance, outsourced CFO services, pass-through entity planning, multi-state apportionment, financial modeling, strategic planning and mergers and acquisitions. Contact John at firstname.lastname@example.org or 717-843-3804.