1031 Exchange for a Self-Storage Facility

Unit buildings, gates, fencing and cameras are real property; the tenant-insurance program and merchandise are not

Almost everything a storage buyer pays for is on the real property lists in Treas. Reg. §1.1031(a)-3: buildings, fences, paved parking areas and roads, outdoor lighting, and security systems and doors as structural components. The office, the climate-control system and the drive aisles exchange with the units.

The business layered on top does not. The regulation's Example 12 holds that a license to operate a business in a building is not real property, and the income streams run from the building, such as tenant-insurance commissions, lock and box sales and truck rentals, along with any trade name or customer list, are business assets (§197 intangibles or inventory) if the buyer pays for them.

When a facility sells as a going business, Publication 544 treats each asset as sold separately, and the Form 8594 instructions require the form for whatever §1031 does not cover. Most owners sidestep the issue by selling the real estate and letting the buyer re-brand, so only the real property price appears in the contract.

Gain and recapture on a storage sale, worked with round numbers

Hypothetically, a facility cost $3,000,000 in 2012: $600,000 land, $2,000,000 buildings and $400,000 of 15-year land improvements such as paving and fencing. By 2026 straight-line depreciation on the buildings is about $670,000 and the improvements are nearly written off, roughly $1,050,000 in total, so the adjusted basis is about $1,950,000 and a $7,000,000 sale with $250,000 of costs produces a $4,800,000 gain.

Character matters more than size. Land improvements are §1250 property because they are neither buildings nor equipment used in manufacturing or utilities (§1245(a)(3) and §1250(c)); their depreciation in excess of straight-line is ordinary income, the rest of the $1,050,000 is unrecaptured §1250 gain at a maximum 25% (Topic 409), and the remaining $3,750,000 is long-term capital gain at 15% or 20%, all potentially subject to the 3.8% NIIT.

If you commissioned a cost-segregation study, cameras, gate operators, signage and kiosks likely sit in 5- or 7-year classes as §1245 property, and an exchange does not reliably defer their recapture: §1245(b)(4) recognizes it up to the boot plus the value of non-§1245 property received, and Publication 544 says this can happen even when no other gain is recognized. Ask your CPA to run that number before you count on full deferral; the regulation itself says its real-property definitions carry no inference for §§1245 and 1250, so a security system can be real property for the exchange and equipment for recapture at once.

Storage to apartments, a mobile home park or a net-lease building: all real property is like-kind

You are not confined to storage. Reg. §1.1031(a)-1(b) looks to the nature or character of property rather than its grade or quality, so a storage facility exchanges for apartments, a manufactured-housing community, farmland or a single-tenant net-lease building without any special showing.

The real decision is how much operating work you want to keep. Buying another facility keeps you in a business of daily move-ins, delinquencies, lien auctions and rate management; a net-lease building removes most of it; a DST removes all of it and can keep you in storage or move you to another sector, as described on our self-storage page and in choosing DST asset classes.

• Stay active: another facility, a portfolio, or an improvement exchange that funds an expansion
• Reduce work: a net-lease building where the tenant carries taxes, insurance and repairs
• Go passive: storage, multifamily or industrial DSTs, which close in days and require no property search by you

Underwriting a storage DST: the master lease decides whether the operator or you carries the lease-up

Because Rev. Rul. 2004-86 bars a DST trustee from entering new leases except in a tenant bankruptcy, a month-to-month storage business cannot be run by the trust directly; sponsors interpose a master tenant that leases the facility from the trust and operates it. Your income is the master-lease rent, so the questions are how that rent compares with facility net operating income and what happens if the operator underperforms, examined on DST master lease risk.

Read the PPM for occupancy and rate history rather than projections, competing supply under construction in the trade area, the age of roofs, paving and gates and the reserves funded for them, and the loan's rate and maturity relative to the projected hold. The general list is on DST due-diligence questions.

Selling three small sites to buy one larger facility: the clocks run from the first closing

If the three sales are part of one deferred exchange and close on different days, Reg. §1.1031(k)-1(b)(2)(iii) starts both the 45-day and 180-day periods on the earliest closing. A sale that lags by two months leaves only four months to close the replacement, so either tighten the closings or run separate exchanges with separate clocks.

Identification follows the usual limits: three properties of any value, or more if their total stays within 200% of what you sold. Consolidating into one larger facility requires the replacement to equal the combined net sale price with the combined debt replaced; if the target falls short, a DST can absorb the difference, the approach in DSTs as backup property, and a reverse exchange handles a target that must close before your sites do.

Weigh consolidation on management rather than tax: one site is one manager and one roof, and a larger facility can be priced and financed differently than three small ones.