"The first step toward making a tax-informed decision on a real estate purchase is to consult with a property tax professional knowledgeable in the market..."
Someone buys a commercial property after months of research and negotiation, and soon afterward the property's real estate taxes skyrocket. The pattern — or at least the degree of the tax increase — often catches even sophisticated buyers unaware because rules that govern real estate assessments vary from state to state and town to town.
Investors who blindly assume that real estate taxes will remain flat after a sale risk disastrous consequences. Tax increases of 50 percent or more are not uncommon following a sale. A clear understanding of how the taxes could change can significantly influence what a buyer is willing to pay for real estate.
"It happens every day," says J. Kieran Jennings, managing partner of Cleveland-based law firm Siegel Jennings, which specializes in commercial property tax. "The phone rings and it's the new owner of a property who has just been hit with a huge tax increase, wanting to know what happened. Sometimes we can fight the tax increase after the fact, but it's always better to know what to expect before you buy. We prefer to get the phone call before the purchase, when we can help plan."
Know the market
Real estate taxes are based on a property's assessment, but tax rules vary widely by location. Some states ban the assessor from changing a property's assessment to match the sale price. Other states automatically raise the assessment to the sale price. Some states have a hybrid system in which a taxing district can file an appeal to increase the assessment after a sale. Knowing the rules of the particular jurisdiction is critical to proper tax planning.
Pennsylvania, for example, has a hybrid system. Pennsylvania law prohibits the county assessor from spot assessing, or independently changing the assessment of only one property. Under another Pennsylvania statute, however, taxing districts can file appeals to increase specific assessments, and many districts use sales to cherry-pick which properties to appeal.
Within Pennsylvania, and even within a particular county, school districts diverge in their practices of filing appeals. In Pittsburgh alone, one district might file appeals on all properties with sales greater than a certain percentage of the assessment, while another district might not file any appeals where the sale price is less than $1 million. A few districts have decided not to file any appeals.
Across the state line, in Ohio, the situation is a little different. Ohio has 88 counties and county auditors set assessments. "It boils down to knowing the county," says Jennings. Ohio has a six-year reappraisal cycle when every property gets a new assessment, and a three-year update cycle when the assessment can be modified.
Owners should expect the sale to be taken into account in a reappraisal year. Mid-cycle, the county auditor also can change an assessment to reflect a sale price. Just as in Pennsylvania, districts can file increase appeals, and many do. Generally, Pennsylvania and Ohio see more increase appeals by taxing districts than do other nearby states.
In New Jersey, the law is similar to Pennsylvania's, but the practical effect is different. "It's a trap for the unwary," says Philip J. Giannuario, a property tax lawyer with Garippa Lotz & Giannuario in New Jersey.
Giannuario cautions property owners to investigate the tax climate carefully before buying. Under New Jersey law, assessments are set by towns. A town's assessor cannot use a recent sale as a reason to change a property's assessment.
Just as in Pennsylvania, such spot assessments are banned. The towns can, however, opt to file assessment appeals to increase the assessments of properties that sell. With more than 650 towns in the state, Giannuario says that whether a particular town actually files increase assessment appeals depends on the town. The key is to know each town's practice.
Budget for worst-case scenario
The first step toward making a tax-informed decision on a real estate purchase is to consult with a property tax professional knowledgeable in the market. Based on the nuances of the particular jurisdiction, if an increase in an assessment is a possibility the tax professional can help the buyer to project a budget as if the assessment were raised to the potential sale price. That analysis could reduce the sum that the potential buyer is willing to offer for the property.
Knowing the worst-case scenario also can help the buyer notify tenants about potential outcomes so that they, in turn, can budget or even escrow funds. A little preparation goes a long way and is an easy step to avoid surprises down the road.