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Property Tax Resources

Jul
09

Expect Increased Property Taxes

Commercial property owners are a tempting target for cash-strapped governments dealing with fallout from COVID-19, writes Morris A. Ellison, a veteran commercial real estate attorney.

Macro impacts of the microscopic COVID-19 virus will subject the property tax system to unprecedented strains, raising the threat that local governments will turn to property tax increases as a panacea for their fiscal woes.

Local governments face formidable financial challenges. One article by Smart Cities Dive suggests that the crisis will blow "massive holes" in municipal budgets, with 96 percent of cities seeing shortfalls due to unanticipated revenue declines. The Washington Post reported that more than 2,100 U.S. cities expect budget shortfalls in 2020, with associated program cuts and staff reductions. The National League of Cities recently estimated that the public sector has lost over 1.5 million jobs since March. Governmental temptation to increase the tax burden on commercial properties will be difficult to resist.

Commercial property owners face similarly unprecedented challenges. Many owners of properties that traditionally served long-term uses for hospitality, retail, office and restaurant activities are now questioning whether those uses will continue. Many properties will need to be repurposed, but to what? Some owners are reportedly considering converting hotels to apartments, for example.

Property taxes are a major component of the costs landlords must examine in determining when and how to reopen. High property taxes, which are generally passed along to commercial tenants, will exacerbate those business' economic problems. While owners can influence some occupancy costs, others, such as taxes and insurance, are largely beyond their control.

RATES, DATES AND VALUES

Real estate taxes reflect both taxation rates and assessed values, but property tax appeals must focus on a property's value. Values hinge on key concepts such as valuation dates, capitalization rates, and highest and best use. The property tax system assumes that values change only gradually, often assessing a property's value by creating a fictitious sale between a willing buyer and seller on a statutorily defined valuation date.

With valuation dates set in the past, assessors tend to value through the rearview mirror. Looking to make a deal, investors, by contrast, look prospectively in deciding whether to buy or sell a property. These viewpoints can clash, particularly when events affecting value occur after the valuation date.

That is why the commercial property owners clamoring for immediate property tax reductions will likely be disappointed, at least until a tax year when their statutorily mandated valuation date postdates COVID-19's onset.

For example, if a taxpayer's bill is based on a fictional sale occurring on Dec. 31, 2019, before the black swan of COVID-19, the assessor is statutorily bound to value the property at its pre-pandemic value.

Some jurisdictions maintain a valuation date for years. That value may change substantially once the valuation date postdates early March 2020, but few state statutes will authorize revaluations based on COVID-19 as a "changed circumstance." A pre-COVID-19 valuation could therefore burden a property for years.

Like the systemic market downturn of 2008, the COVID-19 pandemic will create great uncertainty in capitalization rates, which reflect risk associated with a property's income. This will provide good fodder for argument in tax appeals. The difference this time may be the added uncertainty surrounding the highest and best uses of various commercial properties.

In negotiating a transaction involving income-producing properties, prudent parties analyze future trends. Looking forward, they would interpret weakening tenancy with heightened risk associated with occupancy, rent collections and overall tenant credit-worthiness. They would know that tenants' missed rent payments can lead owners to miss mortgage payments, which can lead to foreclosure.

Contrary to this real-world tendency to look ahead in a transaction, assessors have often assumed a property's highest and best use is its traditional or current use. Trends of working remotely, social distancing, and the rapid, dramatic shift to online retailing turn this assumption on its head.

OBSOLESCENCE ISSUES

Some businesses that closed during the pandemic, including many retailers, may never reopen. Anecdotal evidence of the market shift is manifold. Even before the COVID-19 pandemic, analysts were describing the shift to online retail as "apocalyptic" for many brick-and-mortar stores. Seasoned retailers including Neiman Marcus, Pier 1 Imports and J. C. Penney have declared bankruptcy. Many hotels have only been able to meet debt service obligations by tapping heretofore sacrosanct capital reserves, and airline travel has fallen off a cliff. In April, CNBC estimated that 7.5 million small businesses may not reopen. UBS projects that 20 percent of American restaurants might close permanently.

Social distancing rules that reduce restaurants' serving capacity may remain in place indefinitely. Combined with the loss of clientele, such as office workers that no longer work nearby, these conditions could mean closures for low-margin restaurants. Increasing occupancy costs and revenue declines accompanied by increased taxes could tip the balance.

Office values have historically been less volatile than retail property values, but this may change with the move to remote work. Change will be less apparent where many tenants remain subject to long lease terms, but some form of remote working is likely here to stay, and this suggests office tenants may well need less or different space.

Will an office tenant renew its lease? If so, at what rate? And will the tenant downsize? A key indicator of a weakening market is when tenants with long terms remaining on leases sublet space. In a declining market, tax assessors seldom look behind historic income statements to consider these weaknesses, which should be a risk reflected in the capitalization rate.

DON'T DELAY TAX PLANNING

Retail, office, and hospitality property values almost certainly will decline, at least in the short run. For transactional and property-tax purposes, commercial property owners should examine carefully whether the property's "highest and best use" has changed. Local governments that ignore these market changes in an effort to generate short-term tax revenues may exacerbate their long-term revenue problems.

Smart property owners may be able to mitigate the fallout by focusing tax appeals on the concepts of valuation date and highest and best use. They should also note the uncertainty inherent in capitalization rates.

Tax appeals in 2020 may prove especially challenging for cash-strapped commercial taxpayers because statutorily mandated valuation dates likely predate COVID-19. However, the longer-term risk rests with local governments. If they ignore changes in highest and best uses, and if taxing authorities fail to account for the increased risk in capitalization rates, governments may unwittingly increase the pandemic's economic damage.

Morris Ellison is a partner in the Charleston, S.C., office of the law firm Womble Bond Dickinson (US) LLP. The firm is the South Carolina member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Apr
16

Property Tax Crush Demands Action

Without steps by government officials, coronavirus-related property devaluations won't be taken into consideration, warns veteran tax lawyer Jerome Wallach.

U.S. businesses and lawmakers face an array of challenges related to the COVID-19 pandemic. Looking ahead, let's add one more legislative task to that list which, if addressed early, will better enable the economy to bounce back from the current disruption: Provide tax relief for the owners and tenants of commercial properties devalued by vacancy stemming from the virus and efforts to slow its spread.

One of the only tools available to federal, state and community leaders seeking to slow the spread of the disease has been to limit opportunities for person-to-person transmission. Ever-tightening restrictions, either voluntary or enforced, limit or halt the use of commercial properties ranging from restaurants, bars and hotels to call centers, office buildings, stores, entertainment venues and other structures.

While necessary, these measures will drive growing numbers of tenants into distress up to and including closing their doors, defaulting on lease payments or both. Near term, this will slash property income streams and reduce property owners' ability to pay expenses including property tax on partially or fully vacated properties. Longer term, companies struggling to regain their footing and new tenants moving into spaces vacated during the crisis can expect much of their monthly occupancy costs to include a weighty property tax burden based on assessments completed when real estate values were near all-time highs.

Widespread devaluations likely

Even before President Trump declared a national emergency related to the coronavirus on March 13, researchers were tracking widespread commercial real estate devaluations as reflected in REIT performance. The day before the emergency declaration, economists at the UCLA Anderson School of Management concluded that the U.S. had already entered into a recession. The following Tuesday, March 16, news reports of a Green Street Advisors presentation conveyed that the performance of REITs and drop in share prices suggested investors had marked down asset values, on average, by 24% over the course of the previous month. According to news coverage, a Green Street presenter predicted that private market real estate values would decline by another 5% to 10% over the next six months.

Such a rapid decline in property income and market value creates worrisome property tax implications for taxpayers in most jurisdictions. In months to come, when landlords and tenants may anticipate struggling to recover from the pandemic in a flat or recessionary economic environment, they can also expect to receive property tax bills (or tax liability passed through and attached to their lease obligation) based on pre-crisis property values. In many cases, those assessed values will far exceed current fair market value.

Assessors in the jurisdiction in which this writer practices value real property for ad valorem tax purposes as of the first year in a two-year cycle. This means that, for most local owners, property tax bills they receive this year and last year both reflect their property's fair market value as of Jan. 1, 2019. The time to appeal the 2019 value as set by the assessor has long since run out. Short of an intervening event such as a fire or tornado damage, or perhaps construction or addition of a building or other physical improvement, the Jan. 1, 2019, base value is effectively carved in stone and is no longer subject to legal review or modification.

In those jurisdictions where the value may be determined later, it is most typically set on Jan. 1 of the current year. Even if time remains to contest those values, however, most tax statutes would treat any change in value occurring after the effective valuation date to be irrelevant to tax bills based on that valuation date.

Appeal to lawmakers

COVID-19's impact on property values will be profound if not catastrophic. It would seem to be a callous response for a government official to say, in effect, "So what? The assessor followed the law and valued your property before the pandemic."

A storied law professor used to tell his students, this writer among them, that "there is no wrong without a remedy." Paying taxes based on a value that no longer exists is a wrong, yet there seems to be no immediate remedy.

Indeed, few tax codes will provide taxpayers with relief from the unfair burden they face in the wake of this sudden, global crisis. Remedy will require educating lawmakers and the public about this pending tax dilemma.

Phone calls, letters, texts and emails to government officials at any level may help. Perhaps, together, we will find a solution that balances government revenue requirements with current property values.

Jerome Wallach is a partner at The Wallach Law Firm in St. Louis, the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Feb
03

Why Assessor Estimates Create Ambiguity

Kieran Jennings of Siegel Jennings Co. explains how taxpayers and assessors ensure a fair system, with tremendous swings in assessment and taxes.

A fundamental problem plaguing the property tax system is its reliance on the government's opinion of a property's taxable value. Taxes on income or retail sales reflect hard numbers; real estate assessment produces the only tax in which the government guesses at a fair amount for the taxpayer to pay.

Assessors' estimates of taxable property value create ambiguity and public scrutiny not found in other taxes, and incorrect assessments can lead to fiscal shortfalls that viciously pit taxing authorities against taxpayers seeking to correct those valuations. Worse yet, the longer a tax appeal takes to reach its conclusion, the worse the outcome for both the taxpayer and government. Paradoxically, swift correction of assessment roll protects the tax authority as well as the taxpayer.

As an example, Utah daily newspaper Desert News reported in December 2019 that, due to a clerical error, Wasatch County tax rolls recorded a market-rate value of $987 million for a 1,570-square-foot home built in 1978. The value should have been $302,000. The Wasatch County assessor said the error caused a countywide overvaluation of more than $6 million and created a deficit in five various county taxing jurisdictions, according to the county assessor. The Wasatch County School District had already budgeted nearly $4.4 million, which it was unable to collect.

How does an overvaluation error cause taxing districts to lose money? In many, if not most jurisdictions, the tax rate is determined in part by the overall assessment in the district as well as the budget and levies passed. Typically, there is a somewhat complex formula that turns on the various taxing districts, safeguards and anti-windfall provisions.

Simply stated, tax rates are a result of the budget divided by the overall assessment in the district. A $1 million budget based on a $100 million assessment would require a 1 percent tax rate to collect the budgeted revenue. If the assessment is corrected after the tax rate is set, however, then not all the revenue will be collected and the district will incur a fiscal shortfall.

The sooner a commercial property assessment is corrected the healthier it is for all involved. In the Utah example, had the error been corrected prior to the tax rate being set there would have been no impact on the taxpayer, the school or any of the taxing authorities.

FAIRNESS FOR THE COMMON GOOD

Most state tax systems are flawed and provide inadequate safeguards for taxpayers—if the tax systems were designed better, there would be less need for tax counsel. By understanding the workings of the property tax system, however, taxpayers can help maintain their own fiscal health as well as help to maintain the community's fiscal well being.

As with all negotiations, it is important to understand the opponent's motivations. Although residential tax assessment typically is the largest pool of overall assessment, taxing authorities know that commercial properties individually can have the greatest impact on a system when they are improperly assessed, to the detriment of schools and taxpayers. That makes it important to act as quickly as possible in the event of an improper assessment. And, importantly, resolutions that minimize impacts to the government can maximize the benefit to the taxpayer.

A lack of clear statutory definitions, political tax shifting or a simple error can cause a breakdown in the tax system. In Johnson County, Kan., the assessor raised the assessments on all big box retail stores, in some cases by over 100 percent. Recently, the Kansas State Board of Tax Appeals found those assessments to be excessive. The board reduced taxable values in several of the lead cases back to original levels, and the excessive assessment caused a shortfall.

The Cook County, Ill., assessor has been in the news for raising assessments on commercial real estate in many cases by more than 100 percent. If those assessments are found to be excessive, it could be detrimental for the tax authorities and taxpayers alike. In Cook County, the assessor has stated that the increase is in response to prior underassessment.

SEEK UNIFORMITY, CLARITY

With tremendous swings in assessment and taxes, how can taxpayers and assessors ensure a fair system? Uniform standards and measurements are the answer.

Like the income tax code, the property tax code is criticized for being confusing and overly wordy. To achieve greater equity and predictability, clarity is key. Defined measures of assessed value and standards to ensure uniform assessment results will help create transparency and ensure fundamental fairness between neighbors and competitors, so that no one has an advantage nor a disadvantage.

All taxpayers must be subject to the same measurement. For instance, a government cannot apply an income tax as a tax on gross income for one taxpayer and on net income for another. Likewise, one taxpayer should not be taxed on the value of a property that is available for sale or lease, and another owner taxed based on the value of its property with a tenant in place. Because tax law under most state constitutions must be applied uniformly, one set of rules must be established for all, and what is being taxed should be clearly defined.

Tax laws often include phrases like "true cash value" and "fair value." To be clear, the only measure of taxable value common to all property types is the fee simple, unencumbered value. The value of a property that is measured notwithstanding the current occupant or tenant is not necessarily the price that was paid for the property; it could be higher or lower. And because this concept is difficult for many taxpayers and assessors to understand, there needs to be a second check on the system; that safeguard is taxpayers' right to challenge their assessment based on their neighbors' and competitors' assessments.

To protect themselves on complex matters, it is often helpful for taxpayers to hire counsel that is intimately familiar with the law, real estate valuation and the local individuals with whom the taxpayer will be negotiating. To reduce the need for counsel, get involved with trade groups and state chambers of commerce, which can aid in correcting the tax system.

Uniform measurements of assessment, the ability to challenge the uniformity of results, and swift resolutions combine to create fairness and stability, which in turn enhance the fiscal health of both taxpayers and tax districts.

J. Kieran Jennings is a partner in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Nov
11

How Value Transfers Reduce Tax Liability

Investment value is not market value for property tax purposes because the excess value transfers elsewhere, according to attorney Benjamin Blair. But where does the value go?

When a new building enters the market with a headline-grabbing development budget, the local tax assessor is often happy to use the value stated on the construction permit as a blueprint for a high initial tax burden. After all, would a property owner fight an assessment equal to construction cost? The answer is yes, and here is why the taxpayer should file a protest.

Consider this all-too-common scenario: A new building's publicized development cost is, say, $50 million. The first year after the completion of construction, the assessor assigns the property a market value of $50 million. The owner, now a taxpayer, protests the assessment, relying on an appraisal that shows the property's value to be only $40 million.

The initial reaction of virtually every assessor that faces this common pattern is skepticism—skepticism sometimes shared by the judges deciding the tax appeal. How can it be that the property "lost" $10 million in value so quickly? Why would the owner have even constructed the building if it was an economic loser?

An owner who can explain this value loss—or, more accurately, this value transfer—will be better prepared to ensure a property's tax assessments are based solely on the value of the real estate in question. And, when appropriate, that owner will be prepared to challenge inaccurate assessments.

COST IS NOT MARKET VALUE

Anyone who has ever purchased a new car or made-to-order clothing understands that cost may not equal value. Regardless of the price the buyer paid, those items are worth less to the market after the initial sale. The same factors that immediately depreciate a new car or custom suit affect some types of real estate.

A property can have an off-the-rack market value and then minutes later have a resale value that is different. This does not mean that the owner overpaid for the asset. Rather, the owner paid what the asset was worth to that owner, but a second buyer will not necessarily pay the same price at a later sale.

Real estate buyers will not pay for branding elements, design elements or items of personal preference. When a building is built to the specifications of a specific user, the design, layout and components make it unlikely that cost will equal market value. These buildings exist because they are worth the cost to the first user, not because they inherently have an increased market value.

Investment value is not market value for property tax purposes because the excess value transfers elsewhere. The key question is, where does the value go?

WHERE THE VALUE GOES

Circumstances vary and different properties will transfer value in different ways. Here are some common ways it can occur.

The examples of a custom suit or built-to-suit building illustrate how value can transfer to a person or organization, but value can also transfer to another property. For example, a golf course surrounded by homes is unlikely to have a market value equal to its development cost. The golf course's value is not in the golf course alone; much of its value is reflected in the increased sales prices garnered for the surrounding homes. Likewise, amenities in a subdivision or common spaces in a condominium tower have little value on their own because their value is transferred to the adjacent properties.

Value can also transfer within a property. For example, a parking garage or conference center in a suburban office development is unlikely to generate sufficient rent to make those assets independently feasible, but the increase in rents achievable to the adjoining tenant spaces can make those amenities valuable to the whole. Were the parking garage to sell in the open market, it would almost certainly garner a sale price below its development cost.

Finally, value can transfer to the community. A highway interchange will never have a market value equal to its multimillion-dollar price tag, and public transit systems and arenas would never be justified based on ticket sales alone. Communities deem these projects worthwhile, however. The value of such properties transfers to the community.

Similarly, in many markets the cost of "green" building features, such as a green roof or permeable parking surfaces, is rarely recovered upon the property's sale. Developers still incur those development expenses, even when they will not contribute to the property's profitability. The value of those features is transferred to the community, which receives air purification and water retention benefits.

FIGHT FOR TRANSFERRED VALUE

Understanding the concept of transferred value is important, both because it explains the motivations of those who build and own properties that are worth less than cost to the open market, and because it can help to avoid overvaluing the property. Property can be overvalued in many situations—for example, for insurance or financing purposes—but the pain of overvaluation is most acute in property taxation, since overvaluation generates a higher tax bill and corresponding lower profitability for the life of the asset.

Understanding transferred value can also assist enterprising owners in generating additional revenue streams. If part of the property's value transfers to another person, property or the community at large, then the owner may be able to build a case for monetizing the value transferred to others.

In times of stagnant growth and personnel cutbacks, assessors are eager to capitalize on published construction costs. But by explaining how cost relates to market value, and being able to show where the value went, diligent owners and property managers can reduce fixed expenses, lower tenant occupancy costs and ultimately improve profitability.

Benjamin Blair is a partner in the Indianapolis office of the international law firm Faegre Baker Daniels LLP, the Indiana and Iowa member of American Property Tax Counsel, the national affiliation of property tax attorneys​.
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Mar
28

Unfair Taxation? Governments Need to Fix the Right Problem

​Investors should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class, says attorney Kieran Jennings.

Recently, The New York Times published an article on property taxes imposed on retailers under the headline "As Big Retailers Seek to Cut Their Tax Bills, Towns Bear the Brunt." This and similar articles question the fairness of how retailers have reduced their tax bills by using sales of unoccupied stores as comparable transactions to establish the assessed value for an occupied store.

The local government has cried foul, and the article concentrates on the perceived end result―lost revenue for government coffers.

What is missing from the article is basic tax law, which holds that all taxpayers in a given class must be taxed uniformly. Thus, the series of bad decisions that led local government to overtax retailers made communities dependent on inflated revenue. The initial mistake many assessors made was to seize upon sales prices associated with leased retail stores without critically examining the transactions.

Investors, and taxpayers in general, should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class.

FUNDAMENTALS OF FAIRNESS

Most state constitutions specify that taxes must be uniformly assessed, which requires assessors to follow the same rules for all taxpayers within a class. At the most simplistic level, the rules of the game must be consistently applied to all and not changed to affect the outcome.

To understand how equally applied rules achieve fair taxation of property, bear in mind this fundamental truth: The assessor's goal is to measure the value of real estate only. Taxing entities then use that value to determine the tax. A lack of well-thought-out rules and procedures created the problem of non-uniform assessment.

Many states don't even have a clear definition of what they are trying to measure. States use terms such as "true value" or "true market value" without any further defining language. For most people, fair value simply means what a home would sell for in an open-market transaction. But commercial real estate is not that simple and requires clear definitions applied uniformly to all taxpayers.

Commercial property values are influenced by many factors unrelated to real estate. Consider how, under various circumstances, the same property might sell for wildly different values: An owner-occupied property will sell based on what the market will pay for the building once it is vacant, either for the new owner to occupy or as an investment for the buyer to lease-out at market terms.

The same property, were it leased at an above-market rental rate or to a highly credit-worthy tenant, functions much like a bond and will sell based on a market capitalization rate and for a greater price than the owner-occupied property.

Finally, the same property leased with long-term, below-market lease terms or a less credit-worthy tenant might sell for less than the owner-occupied price or the above-market-leased example. In each scenario, the same property sells for different amounts. Without a clear set of guidelines, establishing value based on sales price would be inconsistent even for a single property, much less an entire class.

Of the three scenarios, the only method that can be replicated consistently and applied to owners of both leased and owner-occupied real estate alike is that of the owner-occupied property. Owner-occupied interest is the unencumbered, fee-simple interest, which makes it the measuring stick common to all taxpayers. All other interests are influenced by non-real-estate factors such as lease terms or business value.

MORE CONFUSION

Adding to the confusion is the ever-changing commercial real estate sector, where market data is full of sales that include non-real-estate influences. The single-tenant market, for example, has evolved from almost exclusively retailer occupancy to include specialty uses and even nursing homes and hospitals.

The assessment goal should be to measure the real estate value alone, ensuring that all taxpayers are taxed with the same measuring stick, but confusion comes in when the sales alone don't indicate real estate value. Leased sales indicate the value of the real estate along with the tenant's credit-worthiness, the life of the lease and a host of other factors that can include enterprise zones and outside influences.

The court cases that are clarifying the methodology and the measuring stick appear to reduce assessments, when they are actually correcting the assessments and requiring assessors to value the same interests for all taxpayers. Defining terms and ensuring rule uniformity protects all taxpayers. There is no foul to be called and the losses affecting some local governments are the result of their own mistakes.

The cure is simple, but the short-term pain for community coffers is significant. States must establish clear definitions and guidelines around property rights so that assessors can value all real estate without encumbrances. Local governments cannot rely on a single taxpayer subset to carry the tax burden.

J. Kieran Jennings is a partner in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Mar
01

Finding Tax Savings in Free-Trade Zones

The FTZ Act prohibits state and local taxes on tangible personal property.  Here's what you should know about the potential for reducing your tax bill.

Foreign-trade zones can offer substantial tax savings for businesses involved in various aspects of manufacturing and international trade. While there are costs involved in setting up and maintaining such a zone, the prospect of escalating trade wars is spurring companies to explore the FTZ designation as a potential cost-control measure.

First, some background. FTZs are the U.S. equivalent of what are known internationally as free trade zones. Authorized under the Foreign Trade Zones Act of 1934, they are usually in or near U.S. Customs and Border Protection ports of entry, and are generally considered outside CBP control. Many communities have integrated these zones into state or local economic development incentive programs.

Broadly speaking, FTZs are designed to stimulate economic growth and development. In an expanding global market, countries increasingly compete for capital, industry, and jobs, and FTZs promote American competitiveness by encouraging companies to maintain and expand their U.S. operations. The zones accomplish this by removing certain disincentives associated with operating in the U.S.

The best-known incentive is designed to level costs among domestic and foreign- manufactured goods. For a product manufactured in a foreign country and imported to the United States, the duty is based on the finished product rather than on its individual parts, materials, or components.

Domestic manufacturers must often pay duties on multiple parts, materials, or components that are imported to be incorporated into a finished product. When those duty payments are added together, the cost of the finished product is higher than for comparable finished goods. FTZs correct this imbalance by assessing duties on products manufactured in an FTZ as if they were manufactured abroad.

Companies operating in FTZs enjoy a number of other benefits:

• No duties or quotas on re-exports

• Deferred customs duties and federal excise taxes on imports

• Streamlined customs procedures

• Exemption from certain state and local taxes

These benefits become increasingly valuable to domestic companies during trade wars, particularly when the disputants impose steep tariffs on manufacturing parts, materials, and components.

STATE AND LOCAL FTZ RULES

FTZs are subject to the laws and regulations of the U.S., as well as those of the states and communities in which they are located, with one significant exception: The Foreign-Trade Zone Act specifically prohibits state and local ad valorem ("on the value") taxation of imported, tangible personal property stored or processed in one of these zones, or of property produced in the United States and held in the zone for export.

Several states, including Arkansas, Kentucky, Louisiana, Maryland, Mississippi, Oklahoma, Texas, Virginia and West Virginia, impose ad valorem tax on business inventory. In a handful of other states, including Alaska, Georgia, Massachusetts, and Michigan, some jurisdictions tax some inventories. But even in these states, most legislatures have carved out "freeport" exemptions from ad valorem taxes on merchandise being shipped through the state.

The problem is, the longer it takes for the merchandise to be shipped out of state, the greater the temptation for an enterprising tax assessor to conclude that the merchandise is no longer actively in transit. In such cases, the exemption may no longer apply and the merchandise could become subject to an inventory ad valorem tax.

FTZs may offer a safe harbor from these taxes. Foreign and domestic merchandise may be moved into a zone for operations, including storage, exhibition, assembly, manufacturing, and processing. Such merchandise may remain in a zone indefinitely, whether or not it is subject to duties. And, while no retail trade of foreign merchandise may be conducted in an FTZ, foreign and domestic merchandise may be stored, examined, sampled, and exhibited in the zone.

Of course, there is a catch. When a proposed FTZ designation could result in a reduction to local tax collections, the zone's governing authority must consider the potential impact on local finances. Specifically, an applicant must identify the local taxes for which collections would be affected, and provide documentation that the affected taxing jurisdictions do not oppose the FTZ designation. Importantly, in jurisdictions that already have "freeport" exemptions to ad valorem taxes, the adverse impact would be limited only to the amount of ad valorem taxes imposed on inventory that is determined by a tax assessor to have come to rest in the state, such that it is no longer subject to the "freeport" exemption.

There are costs associated with FTZs, including application fees and assessments as well as operating fees to maintain the designation. Therefore, individual companies must conduct their own cost/benefit analyses and determine whether these zones are right for them. A competent legal or tax advisor can help to project initial and ongoing costs.

Considering the other trade uncertainties currently buffeting manufacturers, eliminating ad valorem tax exposure alone may warrant using an FTZ.

Angela Adolph is a partner in the law firm of Kean Miller LLP, the Louisiana member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Aug
08

How to Challenge Your Property Tax Assessments

A step-by-step guide from a veteran attorney to navigating the process of disputing real estate valuations by local government.

In most jurisdictions, taxpayers may meet with the assessor or assessor's representative to deliberate and possibly resolve issues concerning taxable real estate valuation.

First, contact the assessor's office to request a meeting. Getting past recorded messages may be a challenge in some instances, but talking to a human being is necessary.

During that initial phone call, be prepared to describe the problem and point of the discussion, then ask for a date and time to meet. Be sure to request the meeting in sufficient advance of filing deadlines for any appeal process.

Before the meeting, identify an objective (typically a lower assessment) and a plan to achieve that outcome. Be optimistic, but recognize that the assessor's office may reject the taxpayer's position. During the discussion, be reasonably flexible; passion and anger are seldom persuasive and will detract from an otherwise sound argument.

Fix the facts

There are a number of valid concerns other than overvaluation which, if properly addressed and corrected, can result in significant savings.

The most obvious reason to discuss the property with the assessor is the need to correct a simple mistake on the part of the assessor's office. Computer-generated assessed values are now widely used and accepted. The resulting values are no better than the data fed into the database, so review assessments with an eye on the broad picture.

Pay particular attention to the address and all measurements, which are common sources of error. Be sure the property hasn't been confused with some other property of greater value. If the property is improved, review the records available on the assessor's website to see if the improvements are accurately described and that the land is properly measured. Call any mistake of fact to the assessor's attention.

Most jurisdictions recognize varying degrees of assessment value depending on property classification. Typical classifications are commercial, residential and agricultural. Each class is assessed at a different percentage of its market value.

Usage is the primary classification determinant. For instance, undeveloped property zoned commercial may be a productive farm, in which case its classification would be agricultural. Point out to the assessor that the property is being farmed and was so used on the tax valuation day. Bring photos and records to establish that farming was the use on value day, and continues to be so.

Make a similar argument in any situation where the assessor classified the property higher than its actual use. Along the lines of classification, some properties are exempt from taxation if used regularly for charitable, religious and educational purposes.

Unless the use is easily recognized and accepted, it is unlikely the assessor's office will alter its opinion in an informal meeting. The meeting is an effort to convince the assessor that the property is overvalued for tax purposes.

Study the concepts

Unless the taxpayer is a valuation expert, it's probable he or she is meeting with someone who knows more about property values than the owner does, or at least believes that to be the case. A fundamental understanding of valuation methods is critical to a meaningful dialogue.

Volumes are written on the subject and the law books are full of cases dealing with value concepts. The following provides a thumbnail sketch of these concepts.

The three approaches accepted by all valuation experts are cost, income, and market or sales comparison. Assessors use these approaches daily, and look at property through these lenses.

Cost. If the property was purchased and improved with a new structure or structures within the last five years, the total cost of acquisition and improvement is a good indicator of what the property is worth and how it should be valued for tax purposes.

In the absence of a recent transaction, a credible opinion of the cost to replace the improvements on the property may be useful. There are manuals recognized by value experts that may assist in obtaining and presenting such an opinion as evidence.

Market. If the house next door, built just like the subject home, sold yesterday, then that sale price is a good indicator of the value of the subject house. On its face, the method of seeing what similar properties sell for seems the simplest and most direct way to determine a property's value.

If only it were so. The more variances there are between the properties, the greater the comparison challenge. Differences can include location, date of sale, condition of the property—the list goes on.

In dealing with the assessor, present listings and recent sales of properties similar to the subject property, if possible.

Income. In short, this is the present value of future benefits, and is the price a knowledgeable person would pay to acquire the future income stream of a given property.

Under this approach, value is typically determined by dividing the net income by the capitalization rate, or the buyer's initial annual rate of return. The capitalization rate, or cap rate, provides a formula for value calculation, and the higher the cap rate, the lower the value conclusion. The assessor will have a firm opinion of the cap rate and is unlikely to be swayed, but it's worth a try.

In many instances, arguing the general market cap rate with the assessor is futile. A better approach may be to show why the assessor's cap rate should be adjusted because of conditions unique to the property. Look for conditions that are beyond the owner's control and constitute risk to future income.

Arguments challenging the assessor's cap rate could include the greater risk of lost income due to external factors, such as a highway change or a major demographic shift.

Assessors and their staff consider themselves professionals meriting respect as public servants. To achieve any result from conversing with them, they should be dealt with accordingly.

At the conclusion of the meeting, be sure to document any agreement reached.



Jerome Wallach is a partner at The Wallach Law Firm in St. Louis, the Missouri State member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Sep
01

Don't Let Taxing Authorities Kill Your Deal

Tips from a veteran attorney on handling the assessments that can spell the difference between a successful closing and coming up short.

Almost every week, I get calls from brokers or investors who want to know how property taxes could impact a potential purchase. With property taxes forming the largest variable expense in most real estate acquisitions, investors should question the tax implications of every deal.

In some jurisdictions, the effective property tax can reach 5 percent of market value, so an unexpected increase can cause a deal to go under. With planning and an understanding of the local environment, however, investors can fully appreciate the risks and expenses, and may be able to come in with a winning bid in a tight market.

Most of the inquiries I receive relate to properties in Ohio or Pennsylvania, where school districts can, and do, file appeals to raise taxes on real estate. In those states, the aggressor is often a school board that seeks to value an asset based on its recent sale price. In other states, it may be the county assessor. Some states have deemed it unconstitutional to "chase" sales in setting taxable value.

Know your district

Knowing which states have aggressive taxing authorities can reveal potential problems, but familiarity with those agencies and their personnel is the key to deciding whether to walk away from a deal or to stay and find a creative solution, resulting in a deal that is favorable to everyone.

An examination of any real estate purchase, whether office, retail, hotel, etc., in the context of various taxing districts' behavior illustrates the importance of thoroughly knowing your taxing authority. In all the following examples, assume that the property is uniformly assessed and that the current assessment is consistent with the value of competing properties.

Also assume that the property is assessed for less than the proposed sale price, and that increasing taxable value to the amount of the purchase price would ruin the deal.The first example takes the case of a taxing district with an aggressive, unyielding district attorney. The tax district's counsel is unwilling or unable to see that the tax increase will end up lowering the property's value below the purchase price.

In this scenario, the assessment is raised to the purchase price, which becomes part of the tax budget. Since taxing entities typically establish tax rates based on the overall assessment of the community, the tax district only gets a single year's increase in tax revenue. In subsequent years, the newly increased tax burden weighs down the property's market value, ending in an eventual refund of taxes. The net effect is a loss for the district and a loss for the taxpayer, though the taxpayer eventually recovers some of those losses. It is altogether a lose-lose situation.

Big gambles

The relatively passive school district occasionally files an increase appeal and generally isn't driven to get the last penny from the taxpayer. At first this seems like a good situation. Although a passive district may be less difficult to deal with than a more aggressive counterpart, it still leaves the buyer with a great deal of uncertainty. Risking large sums of money on chance is gambling, not investing.

The advice to the investor in a passive district rests greatly upon the taxpayer's risk tolerance, and upon local counsel's experience with how cases are typically settled. In some instances, the investor could assume that the case would be settled similarly to past cases. This requires counsel that has enough experience with the district to gauge the risk as well as the possible outcome. It also requires that the buyer fully understand the nature of the risk.

Finally, there are districts with counsel that is both reasonable and creative. In that situation, attorneys have been able to resolve tax questions with the district in advance of closing. This allows for the obvious decrease in risk. As in the previous example, it takes a great deal of experience with the opposing attorney.

Of note, approaching a district early can produce a better result. Taxing authorities have become more likely to pursue appeals of assessments, and the chances that a sale will go unnoticed—and that an assessment will go unchanged—are becoming slimmer.

Due diligence means more than determining what might happen; it requires arranging the deal to whatever extent is possible to bring about the desired outcome. Paper the file with an appraisal that satisfies any allocations, and make notations in the purchase agreement that support the tax strategy.

Being able to explain the nature of the purchase later in a tax hearing is important, but having facts and documents that support those assertions is much more valuable. With the right opportunity and preparation, an investor may be able to enter into an acquisition while eliminating risk that has driven away the competition.

J. Kieran Jennings is a Partner at the law firm Siegel Jennings Co, L.P.A., which has offices in Cleveland and Pittsburgh. The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. Kieran can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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May
25

Property Tax Tip: Beware of Misleading Comp Sales

Are you challenging an assessment?  

A veteran tax attorney urges a close look at sales comps used by the assessor, which may not reflect your asset's true market value.

To estimate a property’s value for taxation, assessors customarily draw on in-house databases.  Sales chosen for comparison are selected on the basis of general characteristics, such as location, use and zoning.

However, those characteristics do not tell the entire story. To begin with, databases are neither designed nor maintained to record crucial details. Although buyer motivation is assumed to be implicit within the transaction that information is rarely included, if ever.

In practice, no two property sales are identical. In order for the assessor to draw value conclusions, comparisons must reflect adjustments for the unique characteristics affecting the price. A real property transaction may meet one standard of a market sale: the arm’s-length test, which establishes that the buyer and seller are independent and acting in their own interest.

FINDING THE MOTIVE

Nevertheless, the taxpayer must examine the buyer’s motivation, which may very well turn out to disqualify the transaction as a comparable market sale. If the buyer’s needs are unique to that transaction, reflecting a motive that other investors are unlikely to share or value, that disqualifies the exchange as a valid transaction for comparison.

The assessor’s records should include such basic information as the buyer and seller, the property’s size and location and the closing date. This provides a starting point for further inquiry.

In many instances, the needs of the seller or buyer create an exchange value unique to the parties and do not reflect market value. They may include one or more of the following situations.

Strategic premium. The buyer under this scenario is protecting its own enterprise by eliminating opportunities for competitors to move into its trade area. An owner of convenience stores that sell gasoline, for example, may acquire sites likely to attract other operators, impose deed restrictions that preclude competition, and resell the restricted property. To that convenience-store owner, the value of the deal is to enhance sales volume by eliminating competition. Other categories of retail chains may employ the strategy. One big-box retailer typically imposes deed restrictions on sites it vacates, thus thwarting competitors from moving into its former space.

Part of a larger deal. The assignment of value within a portfolio transaction is always subject to question. When investors buy multiple properties in a single deal, they may be compelled to take on some under-performing assets along with the most desirable ones. For that reason, values assigned to individual assets in the transaction may be arbitrary, or at best driven by other priorities, not the least of which may be depreciation schedules for federal tax purposes.

Unique buyer needs. A business that must expand its footprint to keep growing has two choices: Buy the property next door, or move to a larger location. The value of the neighboring property to that buyer does not necessarily reflect how the market would typically value the property, but indicates only the buyer’s need at that time.

Sale-leasebacks. The transfer of a property with a leaseback agreement is more a financing arrangement than a conventional sale. It generates cash for the seller and returns to the buyer through lease payments that may bear little or no relation to actual market lease rates. The value in exchange lies in the entirety of the arrangement, which is essentially equivalent to a loan secured by a deed of trust that includes outside collateral.

Assemblage. In order to create a parcel large enough to meet its needs, a buyer may acquire several tracts to create a single property. The individual parcels cease to exist separately and become an undefined part of the new, larger assemblage. Sometimes the owner of the key tract—perhaps the final one required to complete the assemblage—is able to extract a higher price than the property would otherwise command. To the buyer, it is a must-have piece without which the project cannot be completed. Since the buyer pays more than the market value, the excessive price is an unreliable barometer.

These examples demonstrate that the values an assessor references as comparable purchase prices may well be misleading. Indeed, the prices paid for those assets regularly stem from strategic priorities, rather than from actual market. By carefully examining the assessor’s database of comparable sales, taxpayers can reduce property assessments that do not reflect the fair market value of a property.

 

Wallach90Jerome Wallach is the senior partner in The Wallach Law Firm based in St. Louis, Missouri. The firm is the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys. Jerry Wallach can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Apr
17

Solid Base: Proper Lease Structures Can Reduce Property Taxes

In Washington, D.C., as in so many jurisdictions throughout the country, commercial property assessments and taxes have steadily increased for the last five years.  For large office buildings in the District, real estate taxes now constitute an approximately 45 percent slice of the expense pie.  It is not surprising, then, that these tax hikes are generating mounting concern from landlords and tenants, with each side seeking to minimize the impact on the bottom line.

Triple-net leases enable landlords to pass increased property tax expenses to tenants, yet that situation tends to be the exception.  Most office tenants in Washington and other major markets lease space on a full-service basis, so that occupants are typically responsible for increases in real estate taxes only over a pre-established base.

Given this prevailing lease structure, tenants are become increasingly sensitive to how the base is structured.  During the past two years, we’ve noticed a significant uptick in requests from landlords for help with structuring, interpreting and negotiating base years.  The best advice can be summed up as: “Be prepared, be precise and be flexible.”

Be Prepared

Real estate taxes are generally the single largest expense for almost any owner, no matter the state in which the property exists.

During negotiations, landlords should recognize the significance of this cost to the tenant, and assume that the tenant will do the same.  This means that a landlord needs a clear understanding of the property’s current and projected real estate tax situation.

For stabilized properties, current property taxes are a reliable indicator of future taxes, prior to adjustments for changing market conditions.  For new construction or recently renovated properties, however, property taxes can spike in the years following substantial completion.  Understanding a property’s current and likely future assessment will place the landlord in the best possible position during negotiations.

Too often, however, landlords reach out to property tax counsel at the tail end of lease negotiations, after tenants and landlord have already exchanged lease language.  Rather, landlords should consult counsel at the outset of negotiations so that owner and adviser understand the property’s current and projected real estate taxes.

Be Precise

As with any lease clause, precision matters in property tax provisions.  Base-year disputes most often arise when leases use boilerplate language which is either open for interpretation or simply does not apply to the local jurisdiction.  Often this language relies on standard broker/landlord leases and uses generic terms or those that do not clearly apply to the assessing jurisdiction.

Moreover, imprecise language increases the likelihood that costly disputes will arise.  Concerns about base-year language often stalls dispositions or scuttles them altogether.  To minimize the chances of such mishaps, tax-related language should be tailored to the property and jurisdiction.  Again, consulting local property tax counsel is crucial.

Flexibility is Key

There are many ways to negotiate a real estate tax recovery clause.  In the Washington, D.C., metro, standard practice is to set either the first year of the lease or first full calendar year of the lease.  While this standard practice has some superficial logic, it may result in a base year that comprises multiple fiscal years.  For example, Washington’s fiscal year runs from October to September.  As a result, any base year patterned on the calendar year will necessarily require two assessments and could spark a dispute if those assessments differ significantly.

Mindful of this possibility, some landlords and tenants prefer to set base years on the District’s fiscal calendar so that only one assessment will be implicated.  Sometimes, however, the parties are unable to agree on a time period for the base year.  In such cases, taxpayers should shift from a temporal approach to a numeric approach.

For example, if the parties are at loggerheads over whether the base year should be 2016 or 2017, they can simply set a specific assessment or tax amount.  Taking that step can reduce the influence of chance in establishing the base.

Given the outsized importance of real estate taxes to the bottom line, managing these costs is imperative.  While this calls for engaging local counsel to review and appeal the property’s assessment, it should also include working with counsel at the front end to assist in developing appropriate lease language.

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Scott B. Cryder is a partner in the law firm of Wilkes Artis Chartered, the DIstrict of Columbia member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.  He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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