Ben Vestal
Argus Self Storage Advisors
With a new Presidential administration in office, tax planning is becoming increasingly more relevant and important to investors. When it comes to real estate and self storage, it is important to pay attention to newly proposed policies and plans that will have an impact on your investments. The Biden-Harris plan was published as a component of the platform for the Democratic Party and will require Congress to pass it. Although it will likely have extensive amendments before it is finalized, the plan is clearly taking aim at high earners and has many components that will have a meaningful impact on self storage owners and investors.
Below are some of the proposed policy changes that will impact self-storage owners. Obviously, everyone’s situation is different and in order to accurately understand the impact of these changes on an investment you must understand the details. I am not a CPA and you should speak with your tax advisors to make sure you fully understand the new proposed tax policies before making any adjustments to your investment strategy.
Long-Term Capital Gains:
Capital gains are the taxes you pay on the increase in value that you’ve earned on an asset, such as a self storage property, at the time you transfer the deed to a new owner.
The proposed change is a massive increase in long-term capital gains from 20% currently to the ordinary income level of 39.6% for adjusted gross income over $1,000,000. Typically, long-term capital gains are taxed at a top bracket of 20% depending on the amount of capital gains. The $1,000,000 limit may sound rather large, but with today’s average price of a self storage asset in the $2,800,000+ range (and growing rapidly), these gains are not hard to find. In a time when we are seeing a lot of longtime owners/developers reaching retirement age, longevity of ownership may have less reward than we once thought!
Step-up Basis:
The new administration has proposed eliminating the step-up basis for inherited property. This has long been the self storage owner’s solution to avoiding capital gains taxes. The step-up basis for inherited properties adjusts the cost basis for accounting purposes from whatever the original owner paid for the property to whatever the property’s value is at the time of their death.
For example, let’s assume your parents own a self storage property and paid $1,000,000 for it 25 years ago but today it is worth $5,000,000. Under the current law, if they were to die and pass that property on to you, the cost basis would step up to $5,000,000, the current value and you would only owe capital gains tax on the gain over the $5,000,000 at the time of a sale.
The new Biden plan has proposed eliminating that step-up of basis, so if you inherit the self-storage that your parents bought for $1,000,000 25 years ago, and it is now worth $5,000,000, you would actually pay capital gains taxes on the $4,000,000 of appreciation that has taken place over the last 25 years. Obviously, the devil is in the details but these round numbers are meaningful and should not be taken lightly.
Lower Estate Tax Exemption:
Currently, there is a 40% estate tax on estates valued above $11.58 million. The Biden plan proposes to increase the estate tax rate to 45% and more importantly, reduce the estate tax exemption from $11.58 million to $3.5 million. Currently, the first $11.58 million that you inherit is tax free; if you inherit more, then the estate tax kicks in.
Using the example above where your parents bought a self storage property for $1,000,000 and it is now worth $5,000,000 with the step-up cost basis, it’s suddenly not such a big leap to see how an estate can grow to more than the proposed $3.5 million estate exemption.
Clearly, this is a long-term estate planning topic, but with the rapid appreciation that self storage properties have experienced over the last ten years, this should be front of mind for long-term self storage owners and investors.
Summary:
The three topics addressed above are only a fraction of the overall proposed new tax policies and they have yet to be signed into law. As stated above, the newly proposed tax policies are clearly taking aim at investors and high earners such as self storage owners. While the likelihood that these newly proposed tax policies are implemented in its current form is extremely unlikely, it is very important that self storage owners familiarize themselves with potential outcomes and take the necessary steps to mitigate any negative impact on their self storage investments.
