How to Report Self-Storage Income
Is a self-storage facility in the business of providing customers with a service or merely renting space? The distinction is important for income taxes. In fact, those who answered “service” and whose self-storage facility is profitable, may need to file amended tax returns to recoup taxes paid.
About Self-Employment Taxes
One of the distinctions between service and rental income is that rental income is not subject to self-employment taxes. Self-employment taxes include Social Security and Medicare taxes. The tax can be significant. The tax rate is 15.3 percent, but half of the tax is deductible.
Those who operate as sole proprietors or are taxed as partnerships are subject to self-employment taxes on income for services they provide. Rental income is not subject to self-employment tax. The distinction between a service and rental activity is not always clear. This is particularly true with self-storage, where some owners provide ancillary services in addition to renting space. Luckily, the courts have weighed in on this topic.
Self-Storage Income is Rental Income
In Hopper v. Commissioner, 94 T.C. 542, the U.S. Tax Court considered a case where an attorney owned two self-storage facilities. The self-storage units resulted in a tax loss. The attorney used the tax loss to offset his income from his law practice. This had the effect of reducing the self-employment tax the attorney had to pay.
The IRS conducted an audit and concluded that the self-storage unit loss was a rental activity and not a service. Thus, the IRS argued that the attorney could not reduce self-employment income.
The court agreed with the IRS. The court considered the services a self-storage facility provides to customers. This included providing a soft drink machine, pest control, contents insurance, and the sale of locks, packing materials, and pallets. According to the court, these services were provided for the convenience of the tenants and were minor and incidental.
Reporting Self-Storage Rental Income
As the Hopper case shows, self-storage facility income is a rental activity. Rental activities are not subject to self-employment taxes. Self-storage income should be reported on Schedule E, Supplemental Income and Loss, rather than a Schedule C, Profit and Loss from Business.
Those who reported their income on Schedule C may also have missed common real estate tax savings opportunities. Cost segregation is one such opportunity.
With cost segregation, the self-storage facility is broken down into subcomponents for tax purposes. The property with a shorter tax life is able to be deducted sooner rather than later. In fact, for those who have owned a self-storage facility for several years, they may be entitled to a very large first year deduction for missed depreciation. Those interested in cost segregation should contact Engineered Tax Services (engineeredtaxservices.com/).
While the IRS audit rate is low, audits can be challenging as evidenced by the Hopper case. If the IRS is auditing your tax return or you have a tax dispute with the IRS, you might contact Former IRS Attorney Kreig Mitchell (irstaxtrouble.com/) about how to navigate the IRS audit, appeal or litigation process.
Those who are reporting their self-storage income on Schedule C or who may be overpaying their taxes, should contact Jerry Jones, the Self Storage CPA, about their options.