Even when viewed as a mere piece of real property, mini-storage facilities have, upon closer inspection, several discrete facets, the identification of which can greatly enhance the depreciation tax benefits of ownership. Self-storage facilities are distinguished from most other real estate ventures in their closer resemblance to operating businesses as opposed to more passive rental activities. This distinction is important because it allows potential allocation of some portion of the purchase price to intangible "goodwill" value. Any such allocation to goodwill would be in favor of a like amount otherwise depreciated as part of the cost of the buildings (or, possibly, not depreciated at all as part of the cost of land). Goodwill can be written off (amortized) at a rate approximately two and one-half times faster than a like amount allocated to buildings.

Careful attention to these precepts when setting up the depreciation and amortization of newly acquired facilities can significantly accelerate income tax deductions associated therewith. Accelerated tax benefits add additional value when considering the present value of the additional tax which would otherwise be payable in the critical early years of operation under a less propitious cost allocation.

The rest of this discussion is in two parts. The first part discusses depreciation of the physical, tangible, facilities. It concerns itself with only that portion of a facility’s cost not allocated to intangible gong concern value. The last part discusses intangible goodwill value, its tax benefits, how to identify its existence, and ideas on quantifying its value.

Most real estate investments have three tax significant classes of property. The most obvious class consists of buildings and their structural components. Buildings must be depreciated over 39 years. Other than land, which is not depreciable, costs allocated to buildings receive the least favorable tax treatment. Unfortunately, as noted, most, if not all, of the depreciable cost of real estate is allocated to this category. Often over-looked are two other categories for depreciation - land improvements, depreciable over 15 years, and nonstructural fixtures, depreciable over seven years.

Land improvements are common to both ordinary rental real estate and self-storage facilities. However, mini-storage facilities are quite arguably distinguished by a much higher level of personal property/nonstructural fixtures. As noted, this latter category can be depreciated over seven years rather than 39 years, if such property is identified and valued.

Most self-storage facilities have on-site business offices and many have residential space for on-site managers. The furnishings, information, and communication systems associated with these spaces are obvious personal property items which can be depreciated over seven years (five years in the case of computer systems). Additionally, it can be argued that self-storage door systems likewise qualify for personal property depreciation. Most door systems are not custom made for a particular facility. They are purchased separately and installed unaltered. The industry has become standardized in this area. Doors purchased in the original construction phase are frequently and easily replaced. They come in many different standard colors for aesthetic diversity. This standardization, ease of removal, and frequent replacement are traits more common to window covers and carpeting than to structural components of a building. The efficacy of this view is important. Door systems can typically run to 15 percent of the cost of a self-storage structure.

Similar consideration might be given to other facets of a facility which are not integral to its structural integrity. An example of such a high cost item might be the interior hallway system in a packaged metal system facility. Such systems can easily be added to any particular metal building package and are not an integral part of the overarching structure of the facility. An interior hallway system can represent approximately twenty percent of the cost of such a packaged facility. Security systems, often costing upwards of $100,000, should also be considered property which is not a structural component of a facility.

Land improvements comprise that part of the facility representing improvements to the raw land other than the buildings and their structural components. Allocation of the purchase price to such improvements is important because the cost so allocated can be depreciated over 15 years rather than 39 years. Examples of 15-year land improvements common to self-storage facilities include the following:

• Sidewalks
   
• Curbing
   
• Parking spaces
   
• Roads
   
• Fencing
   
• Signage
   
• Drainage facilities
   
• Sewers
   
• Landscaping

In general, this category includes improvements added directly to the property outside of the building and its structural components. When valuing these 15-year improvements from a construction cost perspective, additional indirect costs may be allocable to this category. For example, general conditions and site work could be allocated between this 15-year category and the 39-year category based on relative square footage. The percentage represented by the footprint of the buildings might be allocated to the 39-year category, with the balance of such indirect costs allocated to the 15-year category. Other indirect costs that are candidates for allocation between these two depreciation categories include.

• Construction period interest and real estate taxes.
• Professional services for general conditions such as market studies.
• Contractor fees and sales taxes.

One final consideration regarding this 15-year category concerns the initial purchase of the land. More often than not, the property purchased upon, which the facilities will be constructed, includes some extant improvements that may qualify for 15-year depreciation. Examples of such potentially depreciable land improvements would include asphalt pads, extruded curbing, and leveling and grading. Some portion of the original land cost may, therefore, be depreciable.

Regarding the 39-year category, care should be taken to separately account for those parts of the building that may require removal and replacement prior to the full depreciable life of the overall building. Examples of such costs are roofing and painting. If the cost of roofing is separately identified at time of construction or purchase, there is basis for immediate write-off of the remaining cost thereof when the roof is required to be replaced. The portion of building costs attributable to on-site manager living facilities may qualify as residential, rather than commercial property. Residential costs are depreciable over 27.5 years rather than 39 years.

The allocations discussed herein would be equally applicable to both newly constructed facilities as well as to the acquisition of existing facilities. In the case of self-constructed facilities, individual costs can be tracked and allocated according to logical relationships to the various depreciation categories. When existing facilities are purchased, the task is more difficult. In such cases, it may be necessary to hypothecate construction cost categories and allocate accordingly.

At the outset, it should be noted that goodwill cost allocations apply only in cases of purchases of operating facilities. Such allocations are not appropriate in cases of new construction.

Operating businesses can be distinguished from ordinary real estate investments by the existence of goodwill and other intangible value associated with an operating business. Storage facilities are distinguishable from ordinary rental ventures in several ways. Most rental properties are residential or commercial locations designed for occupancy by people and equipment utilized by commercial occupants. Storage facilities solely house personal property items, retail merchandise, and the like. They often operate under national or regional franchises or have an established local, community reputation for quality that goes beyond mere address or location. The quality of ongoing management as well as signage and advertising are keys to this reputation. Many facilities also engage in other business activities such as personal property rentals of moving equipment and trucks.

These characteristics are indicia of business activities rather than passive real estate rentals. Consequently, the value of an existing facility should be analyzed to determine if goodwill/going concern value is present and, if so, the value thereof. This identification and valuation is important because it allows a portion of the cost of the acquired facility to be allocated to a 15-year intangible asset in favor of 39-year property.

Goodwill is an intangible asset that arises as a result of the name or reputation of the facility, its management, location, customer loyalty, or similar conditions unique to the facility. Traditionally, goodwill has been valued by reference to the excess of the purchase price of an operating business over the sum of the price of the identifiable assets acquired. Obviously such a nebulous valuation methodology presents practical difficulties because this, more qualitative, intangible value is so fused to the value of the property, any allocation to one in favor of the other could prove arbitrary and indefensible in the absence of some sound computational methodology for discerning one aspect of overall value from the other.

As noted, goodwill is the intangible value associated with an operating business. As such, it is equal to the overall value of an operating facility in excess of a like facility in a non-operational state. Thus posited, one way to measure intangible value might be to quantify the lost profits that would be entailed in the acquisition of a hypothetical vacant facility over the course of a normal rent-up period. The operating expenses of a largely vacant facility are not significantly different from a highly occupied facility. Therefore, goodwill value might be derived by measuring the diminished revenues during this hypothetical lease-up period.

Loss of rental income associated with a newly constructed facility can be avoided by purchase of a fully operational facility. Average vacancy rates in excess of normal ongoing vacancies, during a common rent-up period, can be used to quantify this hypothetical loss of rents. Such lost rentals can then be discounted at the appropriate capitalization rate to estimate a value for goodwill.

The following example illustrates this calculation. The facility costs $4.0 million. The facility is fully operational at time of purchase with an ongoing vacancy rate of eight percent. Ongoing monthly rentals are $67,000. If the facility were, hypothetically, vacant, the expected rent-up period would be 30 months. The applicable capitalization rate is nine percent.

Often, the goodwill value assigned to a facility is arbitrary, without reason or logical foundation. As such, there is exposure if the allocation is brought into question. The method proffered above indicates one way of extricating intangible value from the underlying real estate in a rational manner by giving recognition to the economics of an operating facility compared to newly constructed facilities.

An additional element of goodwill value might be added in the case of a storage facility whose historical occupancy rate is higher relevant to a local or national average, e.g. 90 percent. Carrying on with the forgoing example, overall goodwill for the facility is indicated as follows.

When facilities are sold, depreciation claimed with respect to personal property and goodwill must be recaptured as ordinary income (rather than capital gains) to the extent of gain realized with respect to these items. Personal property items tend to decline in value while the related real property tends to appreciate. It is important to give recognition to this tendency when negotiating the relative sales value upon sale of a facility, with an eye towards keeping ordinary recapture income to a minimum.

Storage facilities can give rise to significant tax sheltered income benefits. The foregoing gives ideas on how to more fully exploit these benefits by accounting for the acquisition or construction of facilities giving proper recognition to their true nature and economics. Many of the ideas discussed concern evolving and contradictory areas of the tax law and, therefore, should not be relied upon as a primary source of authority when depreciating actual mini-storage facilities. Hopefully, the ideas raised in this article will cause operators to critically review the cost structure of their facilities to ensure more accurate depreciation, more representative of the true nature of the asset involved.