The Tax Trap of Selling Self Storage and How To Avoid It
Self storage can be a fantastic business and many owners stay in the industry for years. However, there comes a time when owners will want to sell self storage businesses and it's important to plan appropriately for such an event.
If you are thinking about selling your self storage facility, it's imperative to not only start planning, but to start early. The last thing that you want is a realization when you've already begun the process or worse yet
Nowhere is this more true than in planning for the tax implications of selling a facility. Often times, self storage facilities have been owned for a number of years and there is significant equity in the property. That fact, in addition to the fact that self storage property valuations have never been higher, opens up the door to a massive tax burden for the seller once the sale is complete.
It may seem like there isn't anything that can be done to lower the tax implications of selling your self storage, but that's not true! Below are some great strategies that include seller financing, 1031 exchanges, and making sure your properly recording costs associated with the sale.
Many self storage operators are somewhat familiar with the concept of owner financing. Owner financing has been used for years as a way for buyers to be able to qualify for properties they may not have qualified for through traditional bank financing. This includes some current self storage owners who purchased their properties initially with this tactic. However, many sellers don't realize all of the benefits of seller financing.
First, many self storage owners have become accustomed to the monthly residual income from their properties. Owner financing enables this to continue, but at extremely predictable rates and without the hassles of maintenance, vacancies or chasing customers for rent! It's truly putting your monthly income on autopilot for the next 5-25+ years and can be a great option for that reason alone.
Next, and arguably most importantly (at least as far as this post goes) are the tax advantages to owner financing a self storage property. When you sell a self storage facility outright, you are stuck paying capital gains tax to the government in one shot, during a single year. This can often be an incredibly high amount of taxes that can be difficult to come up with. That said, when you owner finance, you're only realizing some of the "Capital Gain" each year. This leaves the self storage seller with a much more manageable tax bill which will again be much easier to plan for over a fixed number of years. Keep in mind, if the self storage seller does a balloon payment at the end of the term (say five years), they will still be stuck paying for all of the capital gains of the balloon payment during a single year. For this reason it can be advantageous for a self storage owner thinking about selling their property to structure the transaction to be split evenly over a number of years.
1031 Exchanges in Self Storage
While we often think when owners want to sell their self storage property that they're getting ready to retire. However, that's not always the case. In some cases they're interested in selling their self storage in order to purchase another self storage property or to move their money to a different real estate asset class.
If that's the case, one extremely powerful tool in the United States is a 1031 Tax Deferred Exchange. The rules around these exchanges are quite in-depth, so we highly recommend finding an attorney who has experience in 1031 exchanges to work with. That said the basics are that you can sell a property "in exchange" for another qualifying real estate asset and defer paying the taxes until you sell the property that you're purchasing. This can technically go on as long as you continue doing 1031 exchanges and the taxes can be deferred indefinitely. Again, there is a ton of nuance in these transactions (timelines, qualifications, filings, etc. etc.) that can be difficult to keep track of. If this sounds like a fit for your situation, go find a qualified attorney!
A final way to lessen the tax burden when selling a self storage facility is to closely track all of the costs associated with selling the property. These can be marketing expenses, commissions, environmental studies, special financial document preparation among other things. Many of these expenses can be deductible, so make sure you're tracking them closely and reporting them to your accountant. We highly recommend working with a CPA that has experience in commercial real estate and self storage if possible. Certified Public Accountants that understand the ins and outs of the industry can be invaluable in not only lessing your tax burden, but making your business as profitable as possible.
In closing, there are a number of options that allow for decreasing your tax liability when you sell your self storage property. At Central Penn Group, we're very experienced in working with sellers to find creative transaction structures that will accomplish their goals, whatever they may be. Whether you're interested in lowering your tax burden or just making sure you'll get guaranteed, predictable monthly payments for years to come, we can help make selling your self storage as easy as straightforward as possible. Call us anytime at 717-687-1883 and find out what we can do for you!