Publication V

By Michael McCune
Argus Self Storage Sales Network

Extra!! Extra!! Extra!!
Capital Gains and Self Storage

The Capital Gains Tax won’t get any lower. This law was tough to get passed and when congress finds out what it will cost in the long run (the next administration), they could raise it again.
Many self storage owners are seeing retirement out of the corners of their eyes and have been waiting for this change in capital gains before selling. Also, the law doesn’t have any indexing provision, so there isn’t much incentive to stay around. This law helps make “hot” assets out of all real estate (i.e.: more volatility).

Combined with high prices, an abundance of buyers, and low interest rates, this change in the Capital Gains rate (we think) will cause owners who are thinking about selling to start actually putting their properties on the market. If you are a seller, it certainly looks like an opportune time. As you know, we think self storage is a great investment for the long term -- but if you have specific reasons to sell, now may be the time.

Remember, those among the first to sell, while all the news is still good and the other sellers haven’t yet come to market, find selling a lot easier than those trying to get out when the market goes bad.

The perception is that this new law will create a lot of selling. Will all this selling cause a blip (or more) in the market? It is hard to measure, but it certainly won’t help, and it could be significant, particularly if other factors also change for the worse.

The new Tax Bill has been signed by the President within the month. It does provide capital gain tax relief for individuals, but it is the most convoluted capital gain system that we have ever had. Following is a summary of the major capital gain provisions:

OLD LAW
Assets sold prior to May 7, 1997 - Gain is taxed at maximum of current capital gain rate of 28% or effective individual tax rate, if less. Asset must have been held for 12 months to qualify. Generally no depreciation recapture.

NEW LAW
Asset sold May 7, 1997 to July 29, 1997 - Gain is taxed at 20% (10% for lower bracket individuals). Asset must have been held for 12 months to qualify, but Assets sold July 29, 1997 or after - Gain is taxed at 20% (10% for lower bracket individuals). Assets must have been held for 18 months to qualify, and

• Assets acquired after December 31, 2000 and held for 5 years before sale will qualify for a reduced 18% capital gain rate (8% for lower bracket individuals), but
• Accumulated depreciation is subject to recapture at a rate of 25%, and
• Alternative minimum taxable income is adjusted to take into consideration the lower capital gains rates, and finally
• Collections on installment notes would appear to be taxed under the rules in existence at the date of collection. That is, the gain from a previous installment sale that is deferred into a period covered by the new, lower rates, will benefit from those lower rates if the original sale would have qualified under the new law.

In Other Words...

Perhaps a simple example is the best way to communicate the new rules: Asset acquired in 1989 for $3 million ($1 million land and $2 million building). One million in depreciation has been taken to date of sale. Asset is sold in August of 1997 for $4 million (cash deal).

We would recommend a careful analysis of each individual’s alternative minimum tax situation to get to the true tax impact of a major disposition.

By Zane Dennis, Director of Real Estate Services at Shenkin Kurtz Baker and Company, Denver.