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The Key to a Successful Tax Deferred Self Storage Sale

Posted: 5/16/2017
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Self storage owners face a dilemma as the maturity of their debt approaches. This often triggers owners to become sellers for multiple reasons, whether it is unattractive refinancing options, estate planning issues, redeployment of capital or the desire to diversify their investment and capitalize on low cap rates during peak market cycles. Regardless of the reason, owners have a limited number of options, with pros and cons of each:

  • Sell for cash: Pay a sizable portion of proceeds for capital gains and recapture taxes and see a significant reduction in cash flow from net resulting investment proceeds.
  • Sell for cash and use the proceeds in an Internal Revenue Code (“IRC”) Section 1031 Exchange: This has the advantage of deferring taxes; however, the process can be painful and the identification of the replacement property can be challenging. Additionally, this alternative rarely addresses diversification goals and estate planning issues.
  • Refinance: Like the Section 1031 Exchange option, taxes are deferred. However, the owner faces the challenges of obtaining favorable debt terms and does not accomplish diversification or estate planning objectives. In an increasing interest rate environment, an owner also faces a reduction in cash flows.

Enter the IRC Section 721 Exchange. IRC Section 721 allows an owner of real estate to exchange their ownership to a Real Estate Investment Trust (“REIT”) for equity, typically in the form of operating partnership units. IRC Section 721 provides a number of advantages to a seller including deferral of capital gains and recapturing taxes (the basis of the exchanged property becomes the basis in the partnership units and the tax event is deferred until the holder converts the operating partnership units to common shares of the REIT) without the headaches of finding a replacement property and using a qualified intermediary as is required with an IRC Section 1031 Exchange. An owner also benefits from the diversification of converting a single real estate asset investment into an investment in a well-diversified portfolio of real estate assets, incremental liquidity at the option of the owner, estate planning advantages and receiving strong existing cash flows through dividends on the gross investment proceeds, rather than net proceeds after taxes.

The IRC Section 721 transaction has all the benefits without any of the draw backs of a cash sale, Section 1031 Exchange or refinance options.

The key to a successful IRC Section 721 transaction is having the right partner. The benefits of IRC Section 721 do not matter unless your partner has a proven track record of providing investors with long term appreciation and consistent cash flows. National Storage Affiliates Trust has over 160 years of combined experience through its unique network of participating regional operators. Since its formation in 2013, NSA has completed multiple Section 721 transactions and has grown to become the sixth largest self storage operator in the country, with ownership in over 450 properties in 23 different states.

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