Fighting Unfair Property Assessments

By Joel R. Marcus, As published by Real Estate New York, September, 2004

Recent sales of commercial properties have presented tax assessors with a golden opportunity to levy high property tax assessments.  At the same time, assessments of newly constructed buildings pose a similar threat and this isn't just chump change.  New York City calculates assessments at 45% of fair market value, thus a sale or new development assessed at a fair market value of $500 to $600 per sf could result in taxes of $30 per sf or more.  

But taxpayers stand on firm ground when they challenge their assessments especially, if the assessor uses a sale or the owner's development costs as the basis for valuing the property.  Assessment appeals claim that the only appropriate method of determining assessment value for New York City Class 4 commercial properties is the capitalization of income method.  Under this method, actual or potential net income is capitalized to establish full market value.  To determine net income, owners deduct operating expenses from gross income and then factor in the market vacancy rate, and other factors such as amortized leasing, tenant improvements, free rent and building upgrades.  Owners should raise objections when assessors use any method other than the income method to value their property.

For example, assessing authorities may employ the cost method, where the property value will be estimated by looking at building expenditures the owner incurred.  However, case law shows that the cost approach is only useful in determining the maximum value of a property and the assessment figure this method produces is often unrealistically high.  Recently, use of the cost method caused new office buildings, hotels and residential condominiums to be hit hard with very high appraisals.  If the city uses an appraisal report which relies on actual development costs, the taxpayer's attorney should object on the grounds that no court of appeals case in more than 40 years has valued income-producing property using a cost methodology.  In fact, some courts have rejected these types of appraisals entirely.  

Taxpayers should also object if the assessor values a property based on the sales approach method.  Under this method, a property's value is based on either a recent sale price or the sale price of one or more comparable buildings.  However, sales prices reflect many factors including the unique lease structure and turnover of tenants, planned upgrades and non-real estate factors that are not known to the court or appraisers.  Such non-real estate factors might include the impact of sale-leaseback agreements, tax planning or license agreements.  In a recent Westchester Co. decision, the court struck down a sales comparison approach because the town appraiser did not have knowledge of the leasing and expense history of each property sold.  

A second part of the argument against using the sales approach method involves the fact that buyers of income producing properties usually focus their attention on a property's economic characteristics.  These may include the length of the holding period (short or long term) or the owner's plans for conversion or repositioning of the property, which may result in a tax exemption.

Neither an analysis of public records nor interviews with buyers and sellers can reveal all the economic factors that influenced a buyer's decision to purchase a property.  Furthermore, some sales prices are based on other physical assets or business interests.  The specific assets or business interests would have to be known to the assessor along with the proportion of the sale price attributed to these interests and specifics, in order to identify comparable properties, thus comparing apples to apples.

Recently the US Department of Finance indicated they are moving toward deriving market value from a review of recent sales and using the rates of return on these sales to determine capitalization rates.  However, by ignoring established legal precedents and statutory law, the tax authorities open the door to widespread tax appeals.  Taxpayers must be more vigilant than ever to ensure that their property is not being valued using the sales or cost methods.  When it comes to property assessments, practicing due diligence and tax appeals become the taxpayer's' best allies.

Joel R. Marcus is a partner in the New York City law firm of Pottish Freyberg Marcus & Velazquez LLP.  the firm is the New York City member of American Property Tax Counsel, the national affiliation of property tax attorneys.  Marcus can be contacted at jrm1000@aol.com.