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Robert Gordon: Assessors Seek New Ways to Tax Business Income

Dec 282010

A recurring challenge to prevent over-assessment of commercial property is to separate true real estate value from business value. True real estate value is assessable for property taxation, while business value is not.

Commercial property owners who conduct businesses on their property must be vigilant to ensure that the assessor is not capturing the value of their business operations in the guise of assessing their real estate. This can occur if the assessor assesses the property under an income approach and includes the owner’s business income in his or her computations, claiming that this income is attributable to the real estate rather than to the owner’s independent business operation.

The objective for property owners is to ensure that income solely attributable to the owner’s business is excluded from real estate income. In general, courts are more likely to allow assessors to treat business income as real estate income where it can be demonstrated that the land itself, rather than the business skill of the owner, is primarily generating the income.

Property owners can take steps to protect themselves from assessments that include business income by carefully reviewing the form of the income information they provide to the assessor. Owners should structure their operating statements so that all income sources not directly pertaining to the real estate are reported and categorized separately.

Taking this step makes it easier to argue to the assessor that the separately reported income should not be included in the real estate assessment. By failing to categorize income properly, owners allow their real estate income and other income to be blurred together in a single entry in their operating statement. This needlessly gives the assessor an opportunity to point to the operating statement as proof that the other income is intertwined with the real estate income and is thus assessable.

Robert L. Gordon is a partner with Michael Best & Friedrich LLP in Milwaukee, where he specializes in federal, state and local tax litigation. Michael Best & Friedrich is the Wisconsin member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at rlgordon@michaelbest.com.

How To Avoid Overpaying Hotel Property Taxes

Property Taxation No Responses »

Nov 192010

Assessors in many jurisdictions value hotels based upon comparable sales of similar properties on a per-room basis, resulting in overstated taxable value and unfair tax bills.

In valuing a hotel on a per-room basis, assessors turn a blind eye to the personal property within those rooms. Items like the bed, television, chairs and other personal items are reflected in sales prices, but are not part of the real estate.

Not limited to guest rooms, personal property extends to dining room furniture, computers, lobby furniture and the like. In many jurisdictions, these items are separately assessed as personal property. When personal items are included in a per-room sales analysis, the assessor is effectively double taxing the personal property.

Another non-taxable component of a hotel sales price is the in-place, trained workforce, which represents a portion of the hotel’s start-up cost. The investment in the trained workforce and other pre-opening costs, such as advertising and promotion, are non-realty items, and yet they are reflected in the assessor’s per-room-sales-based valuation.

The room-sale valuation likewise ignores the inherent business value of management and the flag affiliation. These intangible values are not subject to taxation.

A more accurate method of determining value is the income approach. Under this method, a portion of the income must be attributed to personal property to provide for a return of, as well as a return on, the capital investment.

Coupled with an additional adjustment to net operating income as a reserve to replace short-lived items, the assessor can establish an appropriate net operating income. Then applying a proper capitalization rate yields a proper market value.

This approach ensures that hotel real estate taxes are being paid on real estate, and not on personal property and intangibles that the assessor would like to include through a value-per-room approach.

Jerome Wallach is a partner in St. Louis, Mo.-based The Wallach Law Firm, the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at jwallach@wallachlawfirm.com.

Lack of Data Complicates Property Valuation

Property Taxation No Responses »

Oct 122010

As municipalities reassess real estate within their jurisdictions, those counties and cities which are required to rely upon market value, as opposed to formulaic or historic cost based approaches, have a major problem. The lack of transactions in the late 2007-late 2009 time frame means that appraisers’ jobs will be far more complicated.

How to estimate market rent when there are a few tenants signing leases? Is there a way to determine market-based capitalization rates when there are few sales from which rates can be derived? How to calculate band of investment capitalization rates when mortgage financing is so difficult to come by?

When assessors ask themselves these sorts of questions, their reply usually sounds something like this: “I have a job to do. Even in the absence of data, I must determine market value as of my jurisdiction’s assessment date. I will do the best job I can in the circumstances.”

This means that the ad valorem tax valuation of your commercial property today is difficult to calculate and is likely to be too high.

Take the time to review the accuracy of your assessment with competent appraisal and property tax counsel. If you are fortunate enough to own a trophy asset or a property in a major market, go to internet data sources for a preliminary analysis.

Consider market developments after the valuation date. Even though an appraiser or the assessor generally ignores after‑occurring transactions, an equalization board or court may find the information useful.

Look at the values of comparable properties with an eye to determining the equity of your assessment. Even if a valuation appeal isn’t possible, an equalization attack may be an option.

Most importantly, talk with brokers and lenders. They may hold valuable information about failed financing applications, busted transactions and lease negotiations which will be of great assistance in weighing the approximate accuracy of the assessor’s value.

Elliott B. Pollack is chair of the Property Valuation Department of the Connecticut law firm Pullman & Comley, LLC. The firm is the Connecticut member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at ebpollack@pullcom.com.

Paid Rent – Not Lease Rates – Reveal Taxable Value

Property Taxation No Responses »

Sep 032010

Mark Maher

Many states assess commercial property on a fee-simple basis, using market rents and vacancy rates to calculate a property’s potential income and value. That may work in a stable market, where multi-tenant properties have rent rolls that continually turn over and are consistent with market rents.

Few U.S. markets are stable these days, however. In today’s economic tumult, a property’s leased fee position—its value based on contract lease rates—may not reflect current, dire market conditions that can bring down its taxable value. It’s more important than ever to educate the assessor to the realities of leasing in 2010.

In many cases, the data in the rent roll don’t convey the full story of a property’s performance. Tenants may be missing payments or be late in meeting their obligations. Some spaces might be rented but physically vacant as companies close sites and consolidate operations. This “shadow space” that is leased but unoccupied reduces the appeal of the rest of the property to potential new users. Worse yet, shadow space is often available for sublease and directly competes with the landlord for tenants, usually at attractively low rates.

Another common source of overvaluation by assessors is published asking rental rates, which many jurisdictions equate to market rates. Such information is easily available and busy assessors often revert to it as a starting point for valuing properties.

The property owner’s leasing team is the best source of information to establish the new, lower market rents that will produce an assessment in line with true value. The taxpayer can build a case by providing examples of tenants signing leases for low rent, but that task may prove challenging because few tenants are currently taking new space.

As an alternative, property owners can marshal anecdotes of failed leasing efforts in order to counter asking-rent data. Lost and dead leasing deals need to be detailed so that assessors can place themselves in the property owner’s shoes.

Remember that few assessors have experienced a precipitous downturn before. It’s in the taxpayer’s best interest to educate assessors on the realities of leasing in a down market.

Mark Maher is a partner in the Minneapolis-based law firm of Smith Gendler Shiell Sheff Ford & Maher, the Minnesota member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at mmaher@proptaxlaw.com

Don’t Forfeit Your Right to a Tax Appeal

Property Taxation No Responses »

Jul 282010

With real estate values down in all sectors across the nation, tax appeals are climbing to record numbers. In many cases, taxing jurisdictions cannot support or defend the values that are placed on those properties under appeal.

As municipal revenues run thin and state governments cut programs to balance their budgets, those governments understandably want to avoid returning significant amounts of money as tax refunds.

As a result, many taxing authorities are exploiting technicalities in state laws to seek dismissals of valid appeals. That makes it critically important that property owners stay abreast of all state requirements that may bear on tax appeals, and rigorously follow required procedures.

New Jersey’s Chapter 91 statute provides a clear example of the kinds of technicalities state’s employ. The statute requires the assessor to send a request to the owner of income-producing properties and ask for financial data related to the asset. The owner then has 45 days to respond to the demand. If the owner fails to respond in that time, he or she forfeits the right to challenge that year’s assessment.

In a recent New Jersey case, a municipality moved to dismiss an appeal for a failure to respond to the income and expense request. The property owner had designated an agent to receive property tax notices and correspondence. Although the agent received the request, the agent failed to file the form with the municipality.

The owner argued that the strict words of the statute required the assessor to serve the owner directly. The court held that the only address on file was that of the agent, however, and reasoned that the owner was bound by the statute. On those grounds, the court dismissed the case.

The simple lesson to learn from this example is that a number of procedural hurdles exist in each state’s tax law. Taxpayers must become knowledgeable about all applicable procedural rules and create failsafe, redundant systems to guard against the needless loss of their tax appeal rights.

Philip Giannuario is a partner in the Montclair, New Jersey law firm Garippa Lotz & Giannuario, the New Jersey and eastern Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. Phil Giannuario can be reached at phil@taxappeal.com.

When is Rent Not Rent?

Property Taxation No Responses »

Jun 242010

Rental income has always been the touchstone for calculating real property values and is a key element in determining taxable value for ad valorem property taxes. Because it plays such a crucial role in the property tax valuation, paying attention to what rent includes can result in lower tax bills.

Rental income for properties such as multi-family residential is closely associated with real estate usage and is easily capitalized into an indication of taxable value. That is not the case, however, for properties used by service-oriented businesses, such as full-service hotels or stores in high-end retail malls. In those situations, the stream of income generated by the facility may represent both a return to the real property as well as to franchises, branding, or a trained and assembled workforce.

In most states, these non-realty rights and assets are not subject to property tax. If local tax assessors calculate assessments using income that includes a return on non-realty elements, the property owner will overpay property taxes.

Similarly, in those situations where landlords participate in their tenants’ revenues through percentage rent, taxpayers should determine whether those rents represent a return solely to real property or if they also allow the landlord to share in profits that the tenant generates from customer services and branding. This situation frequently arises when private companies operate in government-owned facilities, such as public airports with privately run concessions.

So, what should investment property owners do? First, determine whether service-oriented businesses are operating in the property or whether percentage-rent arrangements are in effect. If either is the case, contact the local tax assessor and learn the basis for the property’s tax valuation. If the assessed value is based on property income, the property tax may be based in part on non-taxable income. In that case, the property should receive a reduction in taxes.

Cris K. O’Neall specializes in ad valorem property tax matters as a partner in the Los Angeles law firm of Cahill, Davis & O’Neall, LLP. His firm is the California member of American Property Tax Counsel, the national affiliation of property tax attorneys. Mr. O’Neall can be contacted at cko@cahilldavis.com.

Valuation Dispute Strategies: 4 Easy Pieces

Property Taxation No Responses »

May 092010

When it’s tax appeal time, taking the right steps can be critical for winning an assessment dispute. Follow these four steps to make the best case.

1. Provide current and accurate property information. Review the assessor’s property card at least annually and correct any errors. This is also an opportunity to determine if there is reason to dispute the valuation. Consider public records, appraiser credentials, and national cost or capitalization guides. Look for inaccurate information regarding land size or improvements, as well as inaccurate depreciation of improvements.

2. Make sure the proper party files the administrative protest. In most jurisdictions, only the owner or owner’s agent can file a protest or appeal a decision of the administrative board. An agent’s authorization by the current owner must be legal or dismissal may result. If there has been an ownership change during the year, determine whether the party filing the appeal is the owner as of the lien date, or as of the payment date. In some states, parties other than the owner can protest, such as tenants or mortgage holders.

3. Make sure that submitted lease information supports the taxpayer’s position as to fair market value. Almost every state requires the assessment of property at fair market value. Not every lease represents the market, however, or results in a proper value calculation.

4. Make sure that all encumbrances, deed covenants and restrictions, environmental contamination or other impairments are considered in the fair market value determination. Any factor may be considered in determining fair market value, so consider the impact of the state of the property’s title, such as easements, conditions and restrictions. Did the assessor compare the asset to similar properties, or to real estate with more profitable uses than those allowed on the taxpayer’s property?

These steps enhance your chances for a successful appeal.

Howard Donovan is a partner in the Birmingham, Ala., law firm of Donovan Fingar, the Alabama member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at whd@donovanfingar.com.