Have Your Intangible Assets Been Included in Your Property Tax Assessment?
"It is important to identify and remove potential intangible assets in any property tax valuation."
What's the difference between an income tax and a property tax? The answer seems simple, but it is one lost on many assessors when valuing property for ad valorem taxation. Most people understand that income taxes reflect the income a business generates. Property taxes, by contrast, are based on the value of the tangible assets of a business. Some assessors lose that distinction when applying the income valuation approach, however, and fail to identify and properly remove non-taxable intangible assets.
As a general rule, assessors determine property tax value using one or more of three methods: the sales comparison, income and cost approaches. For commercial properties, assessors and appraisers favor the income approach because it mirrors the method buyers most often use in the open market. When this approach is used to determine the value of taxable property, however, the net operating income (NOI) must exclude any income stream attributable to an intangible asset.
Intangible property includes assets that have value but are nonphysical, including franchises, trademarks, patents, copyrights, goodwill, equities and contracts, according to The Dictionary of Real Estate Appraisal. Intangible value cannot be imputed to any part of the physical property.
Many commercial businesses have franchise agreements, contract interests and goodwill. These intangible assets are separate and distinct from the physical assets of the business and are generally nontaxable, so the assessor must remove them when determining a property's taxable value. The first step toward that end is to identify the specific intangible assets that contribute to business income.
The operation of a hypothetical hotel provides a simple illustration. A hotel's income stream clearly includes the owner's taxable return from the land and building, but it may also include a host of intangible items that must be removed before the NOI is capitalized into a taxable value. These items may include the hotel's brand; the assembled and trained workforce; maid, concierge and security services; food and beverage outlets; and spa services. Just as the building and underlying land of a McDonald's should not be valued based on the number of hamburgers the restaurant sells, the service and brand components of a hotel's income must be excluded from the value of the taxable assets. While hotels and restaurants are clear examples, it is important to identify and remove potential intangible assets in any property tax valuation.
The proper identification of intangible assets can be more difficult in properties that primarily derive rental income. The tendency is to assume that if a property rents, all of the income is directly attributable to its tangible assets. While this is generally true, there are a few notable exceptions. Above-market leases are properly classified as intangible assets and should be excluded from property tax valuation. An above-market lease creates a contract right that may not be reproducible on the open market.
The Appraisal of Real Estate, published by the Appraisal Institute, provides that "a lease never increases the market value of real property rights to the fee-simple estate. Any potential value increment in excess of a fee-simple estate is attributable to the particular lease contract, and even though the rights may legally 'run with the land,' they constitute contract rather than real estate rights."
This concept can be expanded to other rental-related agreements, like anchor concessions and a shopping center's tenant mix. For example, assume the owner of a shopping center has relationships with several national tenants that rent space in the owner's centers in other locations. If the owner can persuade a few national tenants to rent space in a new center (possibly through concessions or other business agreements), the result is often a synergy that allows for higher overall rents and less vacancy. In this example, the higher rents are attributable to the owner's business relationships, rather than the location or condition of the center, and must be adjusted to remove the intangible enhancements. Intangible assets are generally nontaxable and exist in almost every business. If your property tax assessment is based on the income approach, make sure the income being capitalized is attributable solely to the taxable, tangible assets of the property.