Court Decision Promises to Reduce California Hospitality Property Taxes

A May 22, 2014, decision by the California Court of Appeal may be a game changer for hotel and hospitality property owners and operators. After many years of litigation before local boards of equalization and the courts, in SHC Half Moon Bay v. County of San Mateo, there now appears to be a definitive ruling on whether the "Rushmore approach" may be used to value hotel properties.

First championed by its creator, appraiser Stephen Rushmore, the Rushmore approach is a technique that appraisers use in valuing hotel properties that is intended to remove the value of intangible assets and rights used in hotel operations.

Intangibles, which are generally exempt from property taxation, include assets such as an assembled workforce, service contracts, and hotel management and franchise agreements. Removal of such intangibles is necessary in certain contexts, such as appraisals for property tax purposes. Intangible assets and rights used in the operation of hotels are often closely intertwined with the real property, land and buildings, which are also used in the hotel's operation.

Appraisers have used the Rushmore approach to value hospitality properties for years, and the method enjoys broad acceptance in some contexts, such as with lenders that require appraisals for financing purposes. Yet the Rushmore approach has been a constant source of controversy in the valuation of properties for ad valorem property tax purposes, primarily because the approach fails to remove the entire value (or in some cases any value) of intangibles.

Insufficient Deduction

Stated most simply, the Rushmore approach is supposed to remove the value of intangibles through the deduction of management and franchise fees as an expense when an appraiser or assessor values hospitality properties by capitalizing the revenues generated by such properties.

In its recent decision, the appellate court specifically held that "the deduction of the management and franchise fee from the hotel's projected revenue stream pursuant to the income approach did not—as required by California law—identify and exclude intangible assets" such as workforce and other intangibles. The court also said that the taxing authority had not explained how the deduction of the management and franchise fee captured the value of the intangible property.

Unfortunately, the court's decision upheld the use of the Rushmore approach to remove the value of goodwill for the hotel in the SHC Half Moon Bay case. The court made the decision because the local board of equalization received insufficient evidence on the issue. Because the hotel's goodwill basically represented the value of its franchise, or flag, the court's decision left in place the assessment of that nontaxable intangible.

Fortunately, the appellate court provided a road map for other taxpayers to remove the value of their hotel's franchise value in the future. To achieve that result, taxpayers will have to provide more specific evidence for the value of their hotel franchise or flag, or for other significant hotel intangibles.

Savvy hospitality property owners will find several silver linings in the SHC Half Moon Bay decision. For one, although the ruling came down from a California court, its reasoning has application nationwide.

In addition, the case supports California's general standard for addressing intangibles, which is to identify, value and deduct. For hospitality properties, this means pointing out to the taxing authorities the specific intangibles used in conjunction with the real property and then obtaining an independent appraisal of each identified intangible. The appraised values for all the identified intangibles should then be added together and deducted from the overall value for the hotel, the overall value being calculated from total hotel revenues.

Franchise Value

Also, the taxpayer in the case sought to remove the intangible value of the hotel's franchise using an accounting analysis that was intended for use in financial reporting and which assigned all residual value to goodwill. Careful reading of the Court of Appeal's decision shows that had the hotel separately valued the franchise, as it did for the workforce and other identified intangibles, the outcome might have been very different.

The SHC Half Moon Bay decision has one other benefit in that it confirms that failure by a taxing authority to remove an identified intangible is a legal issue entitled to de novo review by the courts. De novo enables the court to review the case afresh, without reference to previous reviews or assumptions by lower courts or boards. In California, such review is rarely available in judicial appeals of decisions by local boards of equalization, which are difficult to reverse in the courts.

Hospitality property owners should show the SHC Half Moon Bay case to their local assessors and follow the decision by presenting valuations for all of the intangible assets and rights used in their property's operations. If the assessor declines to remove the intangibles in accordance with the appellate court's decision, the owner should pursue their rights before the county board of equalization and in the courts.

Cris K. O'Neall is a partner in the Los Angeles law firm of Cahill, Davis & O'Neall LLP, the California member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Mr. O'Neall can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

The Appraisal Institute Resolvers Some Debates About Nonphysical Assets

After decades of debate in the marketplace and legal battles over the role of intangibles in commercial property valuation, the Appraisal Institute has published a detailed treatise intended to clarify many of the issues in question. For the first time, the organization has devoted an entire chapter to these nonphysical assets in the latest edition of its industry guide, The Appraisal of Real Estate.

There were plenty of reasons for the Appraisal Institute to weigh in on the subject. Intangibles are a familiar concept for anyone involved in property taxation, eminent domain or financial reporting, but have been a long-standing source of disagreement among appraisers, taxpayers and tax assessors. Arguments frequently arise over the allocation of intangibles—or how to determine the portion of value that intangibles contribute to the total assets of a business. In earlier years, some appraisers and market participants even questioned the very existence of intangibles within real estate.

In many states today, intangible assets are exempt from taxation under specific exclusions for property tax valuation. Therefore, intangible assets—and more important, the appropriate methods for allocation have become critical to the appraisal assignment and to the final tax liability.

Over the years, The Appraisal Institute has offered specific seminars, courses and some collections of articles on intangibles, but nothing as specifically on point as Chapter 35 in The Appraisal of Real Estate, 14th Edition, published in late 2013. This chapter, titled "Valuation of Real Property with Related Personal Property or Intangible Property," defines intangible property as nonphysical assets including but not limited to contracts, franchises, trademarks and copyrights, as well as goodwill items such as a valuable trade name and a trained
workforce.

For some property types, the real property usually trades as part of an ongoing operation that includes all of the assets of that business. Examples include healthcare facilities, assisted living and skilled nursing centers, hotels, convenience stores and car washes. In sales of those assets, the total sale price represents the overall value to all the assets of the business, which makes parsing the value among the tangible and intangible components a challenge for appraisers and assessors. The new chapter attempts to clarify when appraisers should be on the lookout for intangibles, stating, "As the proportion of income attributable to non-real estate sources increases, the potential for the property to include intangible assets also rises."

Additionally, the publication cites some existing requirements under Standards Rule 1-4(g) of the Uniform Standards of Professional Appraisal Practice, which states: "When personal property, trade fixtures or intangible items are included in the appraisal, the appraiser must analyze the effect on value of such non-real property items." The chapter goes on to define the three general classes of property as real property, personal property and intangible property, further breaking down each general classification into individual components for each.

It appears the Appraisal Institute is finally comfortable with confirming the existence of intangibles within certain property types, and with describing how to define them and when to look for them. Unfortunately, that is about where the clarity ends.

The chapter continues with an explanation of two different premises for valuation used by business appraisers. Under the going concern premise, the ongoing business is assumed to continue operations indefinitely, and the liquidation premise assumes the business is closed and the assets are sold. The premise that produces the highest-value conclusion is used to develop a final-value opinion. Assuming the going concern premise is used, however, that is just the starting point to develop a total value for all assets. The chapter fails to provide guidance for properly breaking out the value components of each asset.

One logically would expect the next section of the chapter to contain a how-to discussion for developing a supportable allocation value for the intangible components of the total assets. The chapter does offer some suggestions under the three general valuation approaches: income, cost and sales. Regrettably, each approach is delivered with cautious statements and vague examples, with a point-versus-counterpoint followup for each method.

It is understandable that the Appraisal institute is reluctant to state an absolute preference for one method over another when dealing with intangibles. But with this intensely debated issue, a more in-depth discussion with practical recommendations to make credible conclusions would be more useful.

The new chapter is a welcome addition that helps to clarify the issues involved, that provides definitions and ideas, and that suggests what to consider when the appraisal assignment requires an allocation among asset classes. As the chapter's authors acknowledge, the debate is over for the existence of intangibles in real estate. However, it continues when it comes to determining the proper valuation techniques for intangibles.

Michael Shalley is a principal in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on representation of taxpayers in property tax disputes and is the Texas Member of the American Property Tax Counsel. Mike can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

"When Assessors Seek Business Income Information"

Is it appropriate for a tax assessor to use income information in determining taxable value?

That question comes up frequently in property tax cases when assessors seek income information from taxpayers. The answer is that whether a request is appropriate depends on the type of property at issue and the type of income information being sought. In several recent cases involving manufacturing operations, industrial enterprises and other types of businesses, assessors have sought information on income from the business or businesses operating on the property, rather than on income from the property itself.

Often, assessors have a legitimate reason to seek certain types of income information from taxpayers. For instance, if the property type at issue is typically rented in the marketplace, as is the case with an apartment complex or an office building, it will likely be entirely reasonable for the assessor to request, and for taxpayers to use, the property's rents when evaluating its market value. Indeed, investors regularly rely on rental information to determine the price for such property.

However, some types of income data should be excluded from a property assessment. In a number of recent instances, for example, assessors attempting to value manufacturing or industrial properties have sought income and production information relating to the manufacturing process, which is unrelated to the property's income-producing capacity. Where the business is something different from the rental of property and the business income derives principally from assets other than the real estate, reliance on income information will produce misleading conclusions about the value of the real property (whether for taxation or any other purpose).

To better understand the problem, consider a hypothetical downtown office building that houses law firms, accounting firms, travel agencies, dental offices and any number of other tenants. No reasonable assessor would consider the revenues of the tenants in determining the value of the office building.

Why not? Because that business revenue would indicate only the value of the business taking place in the building. Tenant revenues do not determine the building's rent, and no reaonable investor would value the building on the basis of such income information. In short, it is irrelevant.

The same generally goes for production and income information when it comes to manufacturing proeprties. A typical manufacturing process requires personnel, machinery and equpment, managerial expertise and real property. Add to that goodwill and other intangibles that allow the manufacturer to capture market share and sell its products, and it is clear the income from product sales incorpoates value from a number of assets unrelated to the value contribution of the real property.

Special Purposes, Special Properties

Why, then, might assessors seek business income information, and how should taxpayers respond to such requests?

In many markets, manufacturing properties are more lilely to be in owner-occupied rather than leased space, so determining the equivalent of market rents for such properties is difficult. Assessors seeking production or business income information occassionally argue that they cannot use sales data because the property is a special-purpose asset. But even if the property is special purpose, the assessor should not seek and use income information unrelated to the property and its market value.

Attorneys also hear assessors argue that the property represents a special component of, or provides a particular "synergy" to, the taxpayer's business. These assessors contend they need business income information to accurantely reflect the property's true value. But such efforts to capture special value apart from the real estate itself are efforts to tax an intangible, not the property.

In some cases, it may be appropriate to consider income information to determine whether a property suffers obsolescence and is, therefore, over-assessed. For example, if the total income from all operations is insufficient even to support the real property at its current assessed value, an argumnent exists that the real property suffers obsolescence (relative to its assessed value). However, the fact that income shortfalls might indicate obsolescence does not make business income generally indicative of real estate value.

When assessors request business income unrelated to the property or its rent, taxpayers should consider objecting on several grounds: First, if the information is truly unrelated to the property or its rent, the taxpayer should explain that to the assessor \and try to provide only the property's rental information, if available.

Second, taxpayers should guard against the disclosure of proprietary business information. Many states have laws that protect confidential taxpayer data such as information relating to earnings, income, profits, losses and expenses; taxpayers are wll advised to mark that information as confidential and take other steps to avoid public disclosure of any income information they provide to the assessor.

David Suess is a Partner in the Indianapolis law firm of Faegre Baker Daniels LLP, the Indiana member of the American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.. Suess's partner, Brent A. Auberry, contributed insights and edits to the column.

In order to fund proposed transit improvements in the vicinity of Grand Central Terminal, New York City is considering an air-rights zoning change to allow construction of perhaps a dozen buildings, primarily office towers, that would stand taller than is currently permitted. Developers would be asked to pay the city about $250 per square foot to acquire these new air rights, and the city would use the monies to carry out its proposed public improvements.

The pricing of new air rights under the proposal stands to pit the city against some New York property owners, who could see the value of their own air rights slashed as a result. A question with implications for commercial property owners is, how did the city determine the square-foot charge of $250? An article by Laura Kusisto in the Aug. 13 edition of the Wall Street Journal explores the brewing controversy.

The Landauer Valuation & Advisory organization calculated an estimate of value for the city. Landauer is a division of Newmark Grubb Knight Frank, a well-known real estate advisory firm.

Landauer first determined the value of office land in the Grand Central area, then applied a 35 percent discount. According to Robert Von Ancken, its chairman, residential or hotel uses were not considered in valuing the proposed air rights. Landauer relied on current market data and a methodology used in the past by market participants.

Argent Ventures, which already has a dog in this argument because it owns the air rights above Grand Central, has termed $400 a more accurate unit value. Argent's president has asserted that air rights should not be discounted off underlying land values and might even be worth more than land with the same development potential.

Argent bases this on work performed for it by Jerome Haims Realty Inc. and backed by another appraisal firm. However, as Kusisto notes in her Wall Street Journal article, "Argent has an interest in putting a higher price tag on the air rights because it will have to compete with the city to sell air rights to developers if the rezoning passes."

This controversy obviously sets an existing stakeholder against a municipality that needs to encourage growth in a particular submarket. The value of Argent's Grand Central air rights will be sharply influenced by the city's offerings. The city probably cares as much about creating tax flows from the buildings that would float on the newly created air rights as it does about the selling price, although the Wall Street Journal article does not mention this point.

From a valuation perspective, it would be interesting to review the Landauer and Haims studies, if only to learn in detail how these firms valued the right to create what apparently will be millions of square feet of new office product. Issues such as absorption, the impact of the transportation improvements proposed by the city on market values and the data relied upon to upport the appraisers' conclusions could offer a textbook tudy of a very complicated topic.

Ultimately, the New York City Council must vote on the creation and price of the new air rights.

Elliott B. Pollack is a member of Pullman & Comley in Hartford, Connecticut and chair of the firm's Valuation Department. The firm is the Connecticut member of American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

How a Compelling, Well-Prepared Property Tax Appeal Can Defeat An Unlawfully Excessive Assessment

" A compelling case that is well presented gives the taxpayer the best chance at success."

It's no secret to taxpayers that appealing property tax assessments can be challenging. Typically, taxpayers bear both the burden of proof and the risk of a decision that not only protects government revenue but also ignores the facts and applicable law. Nevertheless, sometimes a compelling and well-prepared property tax appeal can result in tax justice.

A 2013 Michigan Tax Tribunal decision exemplifies the potential for achieving a fair outcome. In this case, the tribunal determined the market value of an apartment complex with 779 units. The analysis was substantially the same for both tax years involved, so just the first valuation date is discussed here.

The taxpayer claimed that the property was worth less than $13,400 per unit. Based on sales of apartments in the area, on an absolute and relative basis, this is a low value for an apartment property in the subject market. To prevail, the taxpayer had to carefully present its case using three essential components:

• A convincing explanation of why the subject property's per-unit value was so low;
• A well-reasoned appraisal based upon both the income approach and sales comparison approach, which demonstrated that the property was worth what the taxpayer contended and refuted the contentions and analysis of the government's assessor and appraiser; and
• Legal authorities whose testimony supported the taxpayer's position.
• The taxpayer needed each of these three ingredients to achieve total victory. It would have been insufficient for the taxpayer to have simply presented an appraisal that reached value conclusions supporting their contentions. In recent years, there have been numerous cases where the tribunal found taxpayer-filed appraisals to be flawed and unpersuasive.

Winning the Case

The taxpayer gave a compelling explanation for the property's low value. In this case, the property's one- and two-bedroom units averaged a mere 581 square feet. The onebedroom units, which comprised more than 70 percent of the apartments, were only 550 square feet. Those measurements were far smaller than those of the area's other apartment complexes, which averaged 750 and 850 square feet for one- and two-bedroom units, respectively.

As the owner explained to the tribunal, the original developer had built the units decades before to serve relatively unskilled young adults working in area factories. The small unit sizes made the apartments affordable for these first-time renters.

The Great Recession reduced demand for all types of apartments, which hurt occupancy and rental rates for the entire apartment market. This economic obsolescence adversely impacted the subject property's value. Further, the recession negatively impacted the subject property far more than other apartment properties because the huge downturn eliminated so many factory jobs for relatively young and unskilled workers. As those jobs disappeared, so did single renters who wanted small units, saddling the property with enormous functional obsolescence.

Given these explanations of the property's deficiencies, the judge could readily accept that even when occupancy improved and became stabilized, the complex would have above-market vacancy and would be limited in the rents it could charge, while forcing the owner to bear most of the utility costs.
These facts were an integral part of the direct capitalization income approach in the taxpayer's appraisal. In this income approach, the appraiser first determined the property's net operating income with occupancy that had reached a stabilized level. This required providing and analyzing the income and expenses of comparable properties as well as the subject property's financial results in recent calendar years. The appraiser applied an appropriate capitalization rate to the stabilized net operating income to determine the property's value as stabilized. The appraiser then subtracted the costs of rent concessions and lost rents the property would experience as it increased occupancy to a higher stabilized level.

In the sales comparison approach, the appraiser presented sales of six comparable properties, and where applicable, made adjustments for numerous elements of comparison, including location and age. Significantly, the appraiser's analysis included not only the commonly used per-apartment unit basis but also a per-square-foot analysis.

The appraiser gave some weight to this sales comparison approach but relied primarily on the income approach. Their testimony, supported by testimony of one of the taxpayer's senior managers, not only satisfied the taxpayer's burden of proof but presented a compelling case.

Having heard this powerful evidence, during the cross-examination of the government's witnesses, it was easier for the judge to see the flaws in the assessor's income and sales comparison approaches. Also, the taxpayer's counsel was able to cite a legal precedent to refute the government's cost approach, which ignored functional and economic obsolescence.

Ultimately, the tribunal rejected the government's value contention, which was 50 percent higher than the taxpayer's, and adopted the taxpayer's claimed value.
For taxpayers who are inexperienced in handling property tax appeals, these cases can be fraught with pitfalls that result in excessive taxation and exasperating endings. A compelling case that is well presented, however, gives the taxpayer the best chance at success. And as this case shows, there are times when tax justice is indeed attainable.

Stewart L. Mandell is a partner in the law firm of Honigman Miller Schwartz and Cohn L.L.P., the Michigan member of the 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..

"What assessors may try to ignore is how unsteady this recovery truly is in light of stalled economic growth."

How to Avoid Unfair Tax Assessments Due to the Economic Recovery

By Darlene Sullivan Esq., as published by Commercial Property Tax Executive, April 2013

Property taxes are the largest expense for many commercial real estate owners, so in today's stagnant economic climate, it would be wise to take initiative to ensure that tax assessments fairly represent property values.

Property tax systems vary from state to state, but no matter how the local system operates, there are some key things to keep in mind. As the nation's commercial real estate market continues its slow recovery, local assessors will try to capitalize on what appears to be a visible improvement in the availability of capital and an increased number of real estate transactions. What assessors may try to ignore, however, is how unsteady this recovery truly is in light of stalled economic growth.

One way assessors may attempt to reflect the market's recovery is by applying a lower capitalization rate to an inflated net operating income in order to arrive at a higher assessed value. Capitalization rates are a buyer's expected annual rate of return on a property purchase. Assessors observing improvement in the commercial real estate market will expect a stronger cash flow from the property combined with a decreased risk. Whether or not that expectation applies to the property, it will likely affect assessed value. While it is true that absorption levels have improved across property categories over the past year, rents have remained flat or decreased from pre-recession levels, and revenue growth still has not caught up to what it was five years ago. Local assessors need to be reminded that with revenues still struggling to recover, the absorption gains should not automatically translate into higher assessed values.

Strong performances recently by real estate investment trusts provide another way assessors may try to increase values unfairly. In this scenario, an assessor unfairly applies the limited number of REIT property sales within a sector to all of the assets in the area that fall within the same property code. Yet such a comparison may be inapplicable to a particular asset.

Following are some guidelines to ensure fair treatment from an assessor: First, review the 2013 property assessment promptly and do not miss any appeal deadlines. Most local assessing jurisdictions have Web sites and online resources to guide taxpayers through the appeal process. When reviewing your assessment, ask yourself: Did the value increase, decrease or stay flat from the previous assessment? Scrutinize it and consider an appeal of any increases in assessed value from 2012 to 2013. Second, evaluate the property's individual characteristics: Was occupancy up or down? Did revenues and expenses increase or decrease? Are there any significant items of deferred maintenance? Any changes, either positive or negative, may impact assessed value.

Third, in many states the expectation is that assessed values will increase significantly in 2013. For example, in three of the largest counties in the state of Texas, assessed values increased between 2.5 percent and 9 percent across property types from tax year 2011 to tax year 2012. Given the increased number of transactions and the signs of recovery, property owners should expect increases in 2013 at least equal to those in 2012.

In some cases, however, assessors will be even more aggressive to compensate for what they now perceive to be modest increases in 2012. If an assessment increases significantly, make sure to have the proper tools and a property tax professional to fight that assessment.

Finally, recognize that the management of property taxes may impact how quickly a particular asset recovers from the recession. A lower property tax expense means a higher net operating income and more cash flow. The money can then go back into the asset to cover any capital expenditures or can be distributed back to investors. As an added benefit, lower property taxes can impact other aspects of the property, such as occupancy. For example, keeping the property tax expense under control may allow a shopping center owner to quote lower expenses to prospective tenants, providing an edge over the competition when it comes to attracting and retaining quality retailers.

Be vigilant when it comes to property tax expense in 2013, and don't let the signs of an improving commercial real estate market drive assessed value to distorted proportions. Be aware of tactics your local assessor may be using to increase values, and know how to counter them.

Darlene Sullivan is a partner in the Austin-based law firm of Popp Hutcheson P.L.L.C. 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. Sullivan can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

"It was not of constitutional moment, the court decided, that the Indianapolis lump-sum payers were stuck for the full amount of their assessments while the installment payers received forgiveness reductions. Terminating the installment payers' obligations to make their remaining installments, the court observed, permitted the city to avoid "maintaining an administrative system for years ..."

By Elliott B. Pollack, Esq., Commercial Property Executive, January 2013

Property owners frequently raise legitimate questions about hard-to-fathom differences between assessments of similar properties, as well as the failure of municipal and county assessors to equalize values. Property owners may question the constitutionality of such unreasonable governmental actions in court. Attorneys, however, have long counseled clients that attempting to toss out an assessment, or a valuation system, on constitutional grounds is a very steep hill to climb. The U.S. Supreme Court underscored the accuracy of this advice last June in a rather prosaic piece of litigation involving sewer assessments.

The city of Indianapolis' policy to pay for sewer construction and line extensions was to apportion the cost among abutting lots. After assessing the initial project, the city divided the cost among the number of affected lots. The city also made adjustments to reflect differences in lot size and configuration. Upon completion of the project, each lot received a final assessment. So far, so good.

Once in receipt of the proposed assessment, a lot owner could choose to pay the amount due in a lump sum or in installments, a choice typically given to property owners facing capital assessments in most U.S. jurisdictions. One particular sewer extension project affected 180 Indianapolis homeowners; 38 chose to pay their obligations at once, and the remainder opted for installments.

Just one year later, the city abandoned the lot apportionment assessment methodology, instead adopting a complicated payment plan based on project bond financing, which need not be discussed here. The key to the new system was that it reduced the liability of the individual lot owners affected by this project.

This was good news for the 142 homeowners who had opted for the installment payment plan, but it went over like a lead balloon for the 38 homeowners who had paid in full. Why? Because in the course of adopting the new financing plan, the city forgave all remaining installments owed under the old format but did not attempt to make refunds to those homeowners who had paid in full.

Understandably upset that they did not receive the same financial consideration that the installment payers received, the lump sum payers initiated refund litigation. The property owners met with initial success but lost the case in the Indiana Supreme Court, which ruled that the city had a rational basis for forgiving the remaining installment payments. Among the reasons the city offered, and the court approved, was a reduction in the city's administrative costs because the cost of calculating refunds to the lump sum payers and making refunds did not warrant doing so. The city also indicated an interest in providing financial relief to the installment payment homeowners. The homeowners took their case to the U.S. Supreme Court, which agreed to hear their appeals.

The Supreme Court concluded that as long as "there is any reasonably conceivable state of facts which could provide a rational basis for the decision" made by Indianapolis, it was constitutional. This thinking is in keeping with a long line of rulings that make it clear the justices are almost always unwilling to wade into the tax-fairness swamp. Commentators suggest that this reluctance is based on the court's perception that once it starts deciding whether a particular tax or tax refund plan is constitutional, it will be deluged with hundreds of cases from all over the country. As a result, the court has developed a jurisprudence that requires it to defer broadly to the judgment of local taxing authorities, except in extreme circumstances.

It was not of constitutional moment, the court decided, that the Indianapolis lump-sum payers were stuck for the full amount of their assessments while the installment payers received forgiveness reductions. Terminating the installment payers' obligations to make their remaining installments, the court observed, permitted the city to avoid "maintaining an administrative system for years ... to collect debts arising out of (many different construction) projects involving monthly payments as low as $25 per household."

The fact that Indianapolis authorities were concerned about potential financial hardships that might be suffered by certain installment payers if their remaining obligations were not forgiven stuck in the craw of the lump sum payers and probably made them wonder why the city did not think of their potential financial hardship, as well. Nevertheless, the Supreme Court ruled that the "city's administrative concerns are sufficient to show a rational basis" for its action. Once the court discerned a rational basis, it refused to take its fairness and constitutional analysis any further.

The June 4, 2012, ruling was signed by Justices Breyer, Kennedy, Thomas, Ginsburg, Sotomayor and Kagan. Justices Scalia and Alito joined Chief Justice Roberts' vigorous dissenting opinion.

Elliott B. Pollack is chair of the Property Valuation Department of the Connecticut law firm Pullman & Comley L.L.C. The firm is the Connecticut 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..

How to Save Money by Allocating Prices in Real Estate Transactions

"Federal regulators recognize operations account for a significant component of hotel income and value..."

By Morris A. Ellison, Esq., as published by Commercial Property Executive, December 2012

Commercial real estate investors generally acquire properties based on total cash flow, rather than on the perceived value of the property's individual components generating that cash flow. Increasingly, however, lenders are attempting to underwrite real estate loans through component analyses by breaking down a property into income-generating elements under the theory that separately valuing components reduces risk.

Taxing authorities already generate separate tax bills, often at different rates, for real property, personal property and business licensing fees. A similar approach from lenders, which are under increasing regulatory pressure to reduce risk, may impinge on commercial real estate financing and slow the industry's recovery.

A purchaser often analyzes components of cash flow when evaluating how to improve a property's operational performance and the impact of taxes on potential returns. Common considerations include real estate transfer taxes, allocation of basis for income tax purposes, real and personal property tax assessments, and segregation of readily depreciable or amortizable assets from non-depreciable or non-amortizable assets. Allocation generally involves four components: (i) land (non-depreciable); (ii) buildings or improvements (generally depreciable); (iii) tangible personal property (generally depreciable); and (iv) goodwill or ongoing business value represented by intangible personal property or business enterprise value (BEV).

Hotel properties are prime examples of component analysis, as the analysis is often a major negotiating point. Hotels are generally sold as going concerns—that is, operating businesses with a value distinct the underlying real estate. Integrating a well thought- out allocation into a purchase agreement potentially simplifies recordkeeping yields significant savings on income, property and transfer taxes, sometimes worth tens millions of dollars. The federal Internal Revenue Code applies different depreciation rates and tax calculations to different property types. Commercial businesses with substantial goodwill associated with operations (such as hotels, shopping centers, healthcare facilities and marinas) can significantly benefit from a comprehensive allocation analysis.

For example, much of the value of healthcare facilities rests in operating licenses. These and other intangible assets are generally not subject to ad valorem taxation, and accurately reflecting value will prevent overpaying property taxes due to an incorrect allocation of value. In states where the federal income tax basis is used to calculate property taxes for purchased assets, an allocation analysis is critical. For federal income tax purposes, the tax basis of purchased assets is allocated according to the residual method, which generally allocates a purchase price into classes of assets. Except for land, certain tangible assets are depreciable for federal income tax purposes.

Valuing such assets typically involves obtaining a real estate appraisal, extracting improvement values from land value and valuing tangible personal property such as furniture using the most appropriate methodology for that asset type. Because the federal income tax basis of property is determined at the time of acquisition, allocating the purchase price should be part of due diligence and not put off until after closing. Closing is a great opportunity to establish the various business assets' tax basis, and separate conveyance documents should be prepared for each major asset to document allocated value.

Property Tax Implications

After closing, governments generally separately assess taxes against the real property, tangible personal property and intangible personal property (usually in the form of a business licensing fee).

Tangible personal property, which is subject to a faster depreciation schedule, includes furniture, fixtures, equipment and supplies. Business enterprise value might include startup costs, an assembled workforce, a reservation system and residual intangible assets. The Uniform Standards of Professional Appraisal Practice (USPAP), promulgated by the Appraisal Standards Board of the Appraisal Foundation, require separation of a hotel's business value from other components. However, there is no consensus on the method for calculating BEV.

Some taxing authorities contend BEV is an illusion conjured by disreputable appraisers and property owners seeking to reduce ad valorem taxes, but the Appraisal Institute and federal regulators recognize that the operating business of a hotel, for example, accounts for a significant component of its income and overall value.

Since Oct. 1, 2011, the Small Business Administration has required affiliated lenders to obtain a going-concern appraisal for any real estate involving an ongoing business. Affected property types include hospitality, healthcare facilities, restaurants and nightclubs, entertainment venues, manufacturing firms, office buildings, shopping centers and apartment complexes. SBA lenders must obtain an appraisal valuing the separate components from an appraiser who has taken specified courses in valuing going concerns.

The Office of the Comptroller of the Currency, which regulates commercial banks, simply requires lenders to use a competent appraiser and does not specify course requirements for the appraiser. While OCC appraisals need only comply with USPAP, stricter standards may apply if required by what the OCC calls "principles of safe and sound banking."

USPAP does not specifically require appraisers to value component elements when appraising going-concern properties. Although USPAP Rule 1-4(g) states, "(w)hen personal property, trade fixtures or intangible items are included in the appraisal, the appraiser must analyze the effect on value of such non-real property items," the Appraisal Foundation has made it clear that this standard does not mandate an appraisal of the property's individual components of value. However, "the appraiser may be required to value the individual components because of what the analysis produces and/or the manner in which the analysis was applied." Thus, USPAP implicitly require an appraiser to allocate values under certain circumstances.

The OCC appears to be seeking to require more. The Federal Deposit Insurance Corp. Improvement Act of 1991 imposed additional requirements on institutions subject to OCC regulations, which require each institution to adopt and maintain written real estate lending policies "consistent with principles of safety and soundness and that reflect consideration of the real estate lending guidelines." Exactly what this means is unclear.

A recent article published by the Appraisal Institute contends that appraisals of going concern properties must allocate values. Although not attributable to USPAP requirements, the FDIC, as well as the Financial Institutions Reform, Recovery and Enforcement Act of 1989, may require allocation in order to ensure "safety and soundness." Whether these principles require different interest rates for different components of value remains an open question.

Component analysis makes sense in analyzing operations and in calculating taxes. The ongoing debate over how to calculate BEV, however, illustrates the difficulty of transporting component analysis into transactions and real estate lending. For example, large hotel loans are typically made by a lender's corporate loan department, not the real estate department, and with good reason. Furthermore, incorporating the concept of component analysis into real estate lending seems likely to increase interest rates at a time when available credit is already scarce. That debate is just beginning.

Morris A. Ellison is a member of the Charleston, S.C., office of the law firm Womble Carlyle Sandridge & Rice L.L.P., and is the South Carolina 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..

"The taxing jurisdictions argued that "accounting goodwill is not intangible property but rather taxable tangible property..."

David J. Crapo Esq., as published by Commercial Property Executive Blog, November 2012

A recent Utah Supreme Court decision may influence taxes throughout the country by clarifying whether goodwill is a component of taxable real estate value. Most states exclude intangible property from taxation, so identifying intangible components of a business can significantly reduce property tax liability.

In T-Mobile vs.Utah State Tax Commission, the Court declared that accounting goodwill is intangible property and not subject to property tax. The Court defined goodwill as "a business' reputation, patronage, and other intangible assets that are considered when appraising the business."

The taxing jurisdictions argued that "accounting goodwill is not intangible property but rather taxable tangible property." They relied on a 2000 Utah Supreme Court decision in Beaver County vs. WilTel to argue that the synergistic value of a company's intangible property, working together with the tangible property, constituted enhanced value and was taxable because the enhancement value was directly attributable to tangible property.
As the taxing jurisdictions saw it, goodwill was enhancement value, and therefore taxable.

The Court disagreed with the counties and held that goodwill constitutes intangible property and is therefore not subject to taxation. The Court stated that goodwill includes such items as "customer base, customer service capabilities, presence in geographic markets or locations, nonunion status, strong labor relations, ongoing training programs, and ongoing recruitment programs." The Court then stated that these items "are associated with the business being conducted on the property; they are not directly attributable to tangible property."

By clarifying the accounting of goodwill, the Utah case provides a reference point and reminder for taxpayers nationwide. To ensure that property is not over-assessed and thus overtaxed, it is important to make sure the taxing jurisdictions have made all the proper adjustments to remove intangible property. And that entails the exclusion of business value attributable to goodwill.

David J. Crapo is a partner in the Bountiful, Utah law firm of Crapo Smith, the Utah 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..

"A critical question for the taxpayer is when, if ever, to share that documentation. Appraisal evidence properly prepared with an attorney in advance of litigation will often protect that document from individuals with whom the owner does not wish to share it, and should allow the owner's team the opportunity to present the evidence at the time and place that is most advantageous to the owner..."

By J. Kieran Jennings, Esq., as published by Commercial Property Executive, November 2012

Since 2001, major retailers have closed about 5,000 stores per year. Certainly there are more closings in challenging times, and in other years there are more store openings than closings. There is one constant, however: Real estate owners and operators must determine what to do with vacated space. Assessors also should weigh the impact on the property, and taxpayers should decide how to reduce taxes based on inevitable tenant turnover.

For many years, the assessing community refused to fully recognize the devaluation of a shopping center due to vacancies. Assessors argued that vacant space has worth, and that an income approach to valuation ignores the income-producing potential intrinsic to empty space. In certain instances, the assessor's argument is true, and including an estimate of potential income for vacant space is an integral part of a shopping center assessment. But what should be done when the space no longer has value or becomes a detriment to the property?

Assessors are often reluctant to acknowledge the nominal or negative value of space that no longer adds to a property's value. When that occurs, a financial study of highest and best use can prove that the space simply cannot be reused economically. Specifically, the property owner can show that build-out and other costs required to prepare the space for the highest and best use outweigh the potential rent the space would earn.

Take for instance a small cinema complex that must update to digital projectors or go out of business. An article in the Sept. 30 edition of USA Today described the owner of a four-screen theater who lamented that he lacked the profit margin to support the $250,000 conversion. The cinema operator's plight should raise a question for the real estate assessor. Is the current usage designation of the space, in its current condition, financially feasible? If the answer is no, then the highest and best use study takes a look at the financial viability of either upgrading — in this example, to digital projection — or renovating the space for a different use and user.

When looking at potentially renovating and changing the use of the property, the appraiser or assessor must determine whether the conversion is physically possible. There may be demand for rentable space, but can the existing structure be adapted for that use? Other considerations include whether the use is legally permissible. A bar, hotel or casino may be a great idea, but do zoning and other laws permit the use? The proposed use should also be reasonable and probable. A conversion to a use that harms the rest of the shopping center is not appropriate.

In many secondary markets in particular, the cost of renovation may exceed the amount of rent that would be collected at market rates over the life of the potential lease. Repurposing a cinema, for example, incurs costs that competing retail properties don't have to bear, such as the expense of leveling sloped floors, adjusting ceiling heights and removing lobbies. If the costs do not justify the change, then the appraiser as well as the owner will need to determine if the building is a detriment to the center. In some cases, the only avenue available is demolition of the property, after which the land can be held for future development.

The days of just discussing the issues of obsolete spaces with the assessor are long since over. Chinese Gen. Sun Tzu's famous admonition, "Know your enemy and know yourself, in a hundred battles you will never be in peril," is apropos in tax contests. A successful appeal requires knowing how the opponent ticks and what proof is necessary.

Owners are often best served in preparing for a hearing or meeting by obtaining an appraisal from a reputable third party. A critical question for the taxpayer is when, if ever, to share that documentation. Appraisal evidence properly prepared with an attorney in advance of litigation will often protect that document from individuals with whom the owner does not wish to share it, and should allow the owner's team the opportunity to present the evidence at the time and place that is most advantageous to the owner.

The final question is, when should the taxpayer raise these arguments? Experience suggests that the taxpayer should attack the issue of obsolete space as soon as the market begins to question the existing use. Tax contests can be lengthy, and profitability — or even survival — may depend upon minimizing non-productive expenses such as taxes.

Kieran Jennings is a partner with the law firm of Siegel & Jennings, which focuses its practice on property tax disputes and is the Ohio and Western Pennsylvania 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..