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Beware the Income Approach to Property Tax Assessments

A hotel business relies on much more than the combination of daily room rentals to generate income. Understanding this fact is critical to achieving a fair and accurate property tax assessment, because only the tangible portion of the hotel operation is taxable.

A fundamental issue in virtually every hotel property tax case is the question of how to allocate value among the taxable tangible assets and non-taxable intangible assets. Tangible assets include the land, building, furniture, fixtures and equipment. The intangible assets generally include the hotel brand or franchise, the management team, the assembled work force, contracts with vendors and customers, and any goodwill stemming from the hotel’s operations. The appraisal community has debated how to allocate among these assets for the last 30 years, yet significant divisions remain.

When valuing a hotel for property tax purposes, most assessors will attempt to utilize the income approach: They simply deduct the expenses from the hotel’s revenue and divide the resulting net operating income by a capitalization rate, just as they would if appraising an office building or an apartment complex. The resulting value is meant to mirror what the property would sell for under prevailing market conditions.

The problem with this analysis, of course, is that it fails to recognize the significant portion of hotel income that flows from non-taxable intangible assets. These non­taxable assets are present in nearly every hotel transaction, but should not be incorporated into a property tax assessment.

To understand this misapplication of the income approach, it is helpful to view the relationship between a business’ income and the real estate the business happens to occupy. On one end of the spectrum are office buildings and apartment complexes. These commercial enterprises derive almost 100 percent of revenue from the direct rental of real estate.

On the other end of the range are service oriented businesses like law firms. A law firm’s revenue derives purely from services rendered, and bears almost no relationship to the rent paid to occupy office space. As a result, an appraiser would never determine the value of a law firm’s office space by capitalizing the firm’s net operating income. Yet this is exactly how many assessors value hotels.

This is not to suggest that hotels are pure service businesses like a law firm. Hotels are hybrid businesses that fall somewhere in the middle of the range between these two extremes. While a hotel’s revenue is not limited to rent, there are certainly portions of the income which are directly attributable to the hotel’s real estate and taxable personal property. The key is to differentiate, if possible, how the income is derived from the different classes of assets.

Parsing out the income streams attributable to the taxable and non-taxable assets is an absolute requirement when an assessor applies the income approach to a hotel’s property tax assessment. Tax assessors routinely ignore this task, however. If they recognize the concept of intangibles at all, many simply deduct a standard percentage – say 20 percent – to reflect the hotel’s non-taxable assets.

The taxpayer must demand more. If the assessor is using the same methodology to value your hotel as he or she uses to value an office building, there is a problem. Engage an expert who understands the allocation of intangible assets, and ensure that your hotel’s property tax value is limited to the value of your taxable assets.

Mark_Hutcheson90Mark Hutcheson is a partner with the Austin, Texas law firm of Popp Hutcheson PLLC. The firm devotes its practice to the representation of taxpayers in property tax disputes and is the Texas member of the American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. Hutcheson can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

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