How can an investment turn sour just because of taxes? Consider the investor who purchased what was anticipated to be a stable property. As the investor completes his first three months of operation, the county sends a letter indicating that based on the sale price the local school district has filed a complaint seeking to double the assessment on the property.

Recent case law makes it more difficult to prove that a recent purchase price is not determinative of market value for property tax purposes even if the property is encumbered by a below market lease. In that recent case, the Ohio Supreme Court ruled that the sale price of the property in an undisputedly arm’s-length transaction indicated the true value of the property for taxation purposes. Previously, Ohio courts consistently used the income approach to valuation and held that a property should be valued as if it were available for rent at market terms and conditions. The Court, however, went a step further, overturning that precedent which previously permitted the courts to exclude a sale if other factors affected the purchase price including financing and above or below market leases.

In a case involving a long-term care facility, the Ohio Supreme Court acknowledged that significant amounts of business value are associated with the purchase of long-term care facilities. In that decision, the Court stated that in Ohio we are to assess only the real estate value for real estate tax purposes. These two decisions raise a key question: under what conditions can a taxpayer prevent tax increases based on a recent sale?

Commercial real estate transactions are often complex, involving more than the value of just the real property. Frequently included in the sale are non-real estate items such as furniture and fixtures, service contracts, brand name recognition, the business value of the tenants, non-compete contracts and many other non-real estate items. These non-real estate assets cannot, by law, be taxed as if they were real estate. The Court seems to have allowed for proper allocations between real estate assets and non-real estate assets. Thus, one method of preventing tax increases is to carefully allocate the purchase price whether purchase involves a single property or multiple properties. Another method is to show that the property was purchased under duress, meaning the buyer had no ability to negotiate because he would be out of business unless he purchased the property.

Finally, the Supreme Court has not accepted the purchase of an entity as being determinative of the real estate value alone.

How may a taxpayer defend against a reassessment lawsuit where an inflated purchase price is based on an above market lease. This is especially daunting in light of the Supreme Court’s finding that a recent sale determined the value of the property, notwithstanding the negative effect of its below market lease. Non-market factors, such as a below market lease, are obligations that reduce the profitability of the property and can have a detrimental effect on the value of real estate and its subsequent sale price. However, the addition of a non-real estate item, such as an above market lease, does not improve the value of the real estate. A favorable contract or an above market lease has a positive, identifiable value and is an asset itself. It can only add to the value of all the assets purchased. The value of the real estate for property tax purposes is based on real estate market values not the value of any other identifiable assets associated with the property or purchased in combination with the real estate.

For example, an industrial property received contractual rights to free methane gas as an inducement to locate adjacent to a garbage dump. Now, after numerous increases in the cost of gas, the owner has a substantial competitive advantage by using the gas for its operations and to generate electricity. Obviously the property could be sold for much more with the gas contract than without it. In this instance, a favorable contract for fuel added to the value of the overall asset purchase but had no effect on the real estate. There are many examples that may not be as striking as this one, but nevertheless, it is up to taxpayer to identify the non-real estate items in a purchase and make proper allocations.

The assessors and school districts will not make your allocations for you, and allocations made in the middle of a case have the appearances of being “invented.” Therefore, it’s critical that all proper allocations be made prior to recording the deed.

By recording only the value attributable to the real estate, i.e., land and buildings, taxpayers will have won their argument before it has even begun. Assessors and school district attorneys routinely use the recorded purchase prices to establish value or file lawsuits.

Kieran Jennings is a partner in the Cleveland and Pittsburgh law firm of Siegel Siegel Johnson & Jennings, Co. L.P.A., the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. Kieran Jennings can be reached at kjennings@siegeltax.com.