Property Tax Resources


Disparate Treatment under City's Assessment Forgiveness Plan is Ruled Constitutional: Armour v. City of Indianapolis

By Stephen H. Paul, Esq. and Benjamin A. Blair, Esq. as published by IPT - Tax Report, July 2012

On June 4, 2012, the Supreme Court of the United States issued a significant decision in Armour v. City of Indianapolis, No. 11-161, finding that a city's forgiveness of sewer assessments for some property owners without offering refunds to others did not violate the Equal Protection Clause. Applying a rational basis standard of review, the Court held that administrative concerns can be sufficient to justify tax-related distinctions without running afoul of the Constitution.

On June 4, 2012, the Supreme Court of the United States decided Armour v. City of Indianapolis, No. 11-161, which affirmed the Indiana Supreme Court's ruling that when a city switches from one method of infrastructure financing to another, the city's decision to forgive certain financial obligations arising under the prior financing method may be justified by administrative concerns even when the forgiveness creates disparate consequences. Although ostensibly a sewer-financing case, the Supreme Court's decision directly affects the scope of state and municipal taxing authority and the impact of the Equal Protection Clause on tax-related distinctions.

For more than a century, cities in Indiana have been permitted to apportion the costs of infrastructure projects among all affected property owners by a statute called Barrett Law. When a city built a Barrett Law project, the city would divide the total cost of the project equally amongst the affected lots. The city would issue a lot-by-lot assessment and would collect payment of the assessment in the same manner as other taxes. Barrett Law allowed lot owners to pay the assessment either in a single lump sum or as installment payments over a period of 10, 20, or 30 years with accruing interest. Until fully paid, an assessment constituted a lien against the property, and the city could foreclose on the property in the event of a default.

For several decades, the City of Indianapolis (the "City") used the Barrett Law system to fund sewer projects. One of the Barrett Law projects was the Brisbane/Manning Project, which began in 2001. It connected about 180 homes to the City's sewer infrastructure, and in July 2004, the homeowners were sent formal notice of their payment obligations. Each property was assessed $9,278 for the project, with options for 10-, 20-, and 30-year payment plans at 3.5% interest. Thirty-eight homeowners paid the assessment in full.

In 2005, the City adopted a new system of sewer-financing, the Septic Tank Elimination Program ("STEP"), in which each homeowner was charged a flat fee and the remainder of the cost was financed by bonds paid by all taxpayers. STEP had the advantage of lowering sewer-connection costs for individual lot owners. However, more than 40 Barrett Law sewer projects had been constructed before STEP was adopted, and more than half of those projects still had installment paying lot owners, including the Brisbane/Manning Project, which had been in place for only a year. In enacting STEP, the City decided to forgive all outstanding assessments under the Barrett Law system because the system presented financial hardships on lower income homeowners who most needed sanitary sewer service. However, no refunds would be issued for assessments already paid. Thus, while 38 of the homeowners in the Brisbane/Manning project had paid $9,278, others paid as little as $309.27 for the same sewer connection.

The homeowners who had paid in a lump sum brought a lawsuit seeking a refund from the City, claiming that the City's refusal to provide refunds at the same time that the City forgave outstanding assessments of other homeowners violated the Federal Constitution's Equal Protection Clause, which provides that "no state shall ... deny to any person within its jurisdiction the equal protection of the laws." The trial court granted summary judgment in favor of the homeowners, and the Indiana Court of Appeals affirmed that judgment. The Indiana Supreme Court reversed the lower court, finding that the City's distinction was "rationally related to its legitimate interest in reducing its administrative costs, providing relief for property owners experiencing financial hardship, establishing a clear transition from Barrett Law to STEP, and preserving its limited resources." Slip op. at 5. The homeowners appealed to the U.S. Supreme Court to consider the equal protection question.

In a 6-3 decision, the Supreme Court held that the City's tax-related distinction was supported by a rational basis and thus did not violate the Equal Protection Clause.

The Court began by finding that the proper question was whether the City's distinction between homeowners had a rational basis. Although the Equal Protection Clause strongly protects individual rights in certain circumstances, a classification that does not involve fundamental rights and which does not proceed along suspect lines "cannot run afoul of the Equal Protection Clause if there is a rational relationship between the disparity of treatment and some legitimate purpose." Slip op. at 6. Rational basis review requires deference to reasonable underlying legislative judgments, and legislatures have "especially broad latitude" in creating classifications and distinctions in tax statutes. Id.

The City's classification involved neither a fundamental right nor a suspect classification. "Its subject matter is local, economic, social, and commercial." Id. The City did not discriminate against out-of-state commerce or new residents, actions which would have increased the degree of scrutiny the Court would give to the City's action. The distinction between fully-paid homeowners and those who had their debt forgiven was simply "a tax classification." Id. Hence, the Court found that the case fell directly within the scope of its precedents holding such a law constitutionally valid

if there is a plausible policy reason for the classification, the legislative facts on which the classification is apparently based rationally may have been considered true by the governmental decision maker, and the relationship of the classification to its goal is not so attenuated as to render the distinction arbitrary or irrational.

Slip op. at 7 (quoting Nordlinger v. Hahn, 505 U.S. 1, 11 (1992)).

The Court found that the City's decision to stop collecting outstanding Barrett Law debts was based on rational administrative concerns. Administrative considerations can justify a tax-related distinction. The City's administrative burdens would have included the need to maintain parallel and expensive administrative systems to monitor both the new and the old financing systems, with the possible need to track down defaulting debtors and bring legal action. The fixed administrative costs would have continued to increase on a per-debtor basis as debts were paid off. Further, the City would have to calculate and administer refunds, which would require appropriating funds from other city programs. In other words, the entire purpose of transitioning from Barrett Law to STEP would have been defeated. While the homeowners put forth systems they deemed superior to the one implemented by the City, the Court noted that "the Constitution does not require the City to draw the perfect line nor even to draw a line superior to some other line it might have drawn... only that the line actually drawn be a rational line." Slip op. at 11.

Although the Indiana court held that relieving financial hardship was also a rational governmental concern, the Court noted that it did not need to consider that argument, explicitly holding that "the administrative considerations we have mentioned are sufficient to show a rational basis for the City's distinction." Slip op. at 10. The homeowners correctly stated that administrative considerations could not justify a system where a city arbitrarily allocated taxes among a few citizens while forgiving others simply because it is easier to collect taxes from a few people than from many. "But that is not because administrative considerations can never justify tax differences." Slip op. at 11. "The question is whether reducing those expenses, in the particular circumstances, provides a rational basis justifying the tax difference in question." Slip op. at 12. The Court held that the homeowners had not met their burden of showing that there was no rational basis justifying the distinction.

In a spirited dissent, Chief Justice Roberts noted that the Court had never before held that administrative burdens alone justify grossly disparate tax treatment of those who should be treated alike. "The reason we have rejected this argument is obvious: The Equal Protection Clause does not provide that no State shall 'deny to any person within its jurisdiction the equal protection of the laws, unless it's too much of a bother.'" Dissent at 4. Similarly, the City's argument that the unequal burden was justified because it would have been "fiscally challenging" to issue refunds "gives euphemism a bad name." Dissent at 5. The dissent disagreed that the City could evade returning money to its rightful owner by the "simple expedient of spending it." Dissent at 6.

The City had been presented with three choices: 1) continue to collect installment payments from all homeowners; 2) forgive the debts of installment-plan homeowners and give equivalent refunds to lump-sum homeowners; or 3) forgive future payments and offer no refunds of past payments. "The first two choices had the benefit of complying with state law, treating all of Indianapolis' citizens equally, and comporting with the Constitution." Dissent at 2. The City chose the third option, and the dissent saw the equal protection violation as plain.

The Ongoing Vitality of Allegheny
The Court's decision in Armour will have a significant impact beyond the limits of Indianapolis' sewer system, particularly in the realm of equal protection challenges to state tax regimes.

The most substantial disagreement between the majority and the dissent, and the area where some commentators have expressed concern, is the continuing vitality of Allegheny Pittsburgh Coal Co. v. Commission of Webster County, 488 U.S. 336 (1989). That case involved a county assessor who valued real property on the basis of its recent purchase price, except where the property had not been recently transferred, in which case the assessment for each property remained essentially flat. The system resulted in gross disparities in the assessed value of generally comparable properties. The Constitution allows a State to divide property into different classes, but the division must not be arbitrary and the distinctions in practice must follow state law. The Supreme Court held that the assessments violated the Equal Protection Clause because the Clause requires that similarly situated property owners achieve rough equality in tax treatment.

The majority in Armour distinguished the earlier decision by emphasizing that Allegheny was "the rare case where the facts precluded any alternative reading of state law and thus any alternative rational basis." Slip op. at 13. There, the assessor "clearly and dramatically violated" a clear state law requirement of equal valuation. In contrast, the City in Armour followed state law by apportioning the cost of its Barrett Law projects equally. State law said nothing about how to design a forgiveness program or how to draw rational distinctions in doing so. Thus, to adopt the view of the homeowners "would risk transforming ordinary violations of ordinary state tax law into violations of the Federal Constitution." Slip op. at 13-14.

The dissent found the equal protection violations to be identical between Armour and Allegheny. Whereas the majority spent little time on the Allegheny decision, the dissent saw the cases as direct analogs, even down to the levels of disparity. Whereas the majority found that the City complied with state law, the dissent viewed the state law as requiring the assessment to be equally apportioned amongst the homeowners. The result of the City's decision was that some homeowners were charged 30 times what the City charged their neighbors for the same service.

The fundamentally different treatments given by the majority and the dissent treatments to Allegheny show that Allegheny is still an important case in equal protection claims relating to taxation. The sides disagreed about how central Allegheny is to the argument for rational basis and the manner in which compliance with state law demonstrates a rational basis.

The majority seems to have taken steps to avoid dealing with Allegheny, despite the obvious parallels between the cases. The Court only discussed Allegheny after finding that the City had a rational basis for the distinction. Whereas Allegheny stands for the notion that failure to comply with state law demonstrates a lack of rational basis, the majority found a rational basis and then read the state law in a way that supported its finding.

The dissent viewed compliance with state law as central to the argument for rational basis. If a City's tax regime fails to comply with state law, it fails rational basis review. Thus while the majority took a broad view of compliance, saying that the assessment itself complied with state law, the dissent took a narrow view of compliance, saying that the end result of the tax regime must comply with state law.

Allegheny, though a "rare case", has long provided taxpayers with some guidance on how to proceed in an equal protection challenge to an unequal tax regime. The decision in Armour shows how rare Allegheny truly is, and how difficult the path for future taxpayers will be. The most significant lesson for taxpayers seeking to overturn a tax regime on equal protection grounds is that the bar is set extremely high. Taxpayers who attack legislative line-drawing have the burden of showing that it was not rational for the City to draw the line to avoid an administrative burden. Slip op. at 12. Taxpayers must show that the administrative burden on the municipality is "too insubstantial to justify the classification." Id. The homeowners in Armour were unable to do so. The discriminatory effect in future cases will need to be egregious in order for taxpayers to successfully show an equal protection violation in light of Armour.

The Impact of Armour on Amnesty Programs
The Court's decision in Armour is also significant because it may be broadly interpreted to give state and municipal governments a wide berth in crafting amnesty programs and other tax policies.

The Court drew a parallel between Indianapolis' assessment forgiveness and other common amnesty programs involving mortgage payments, taxes, and parking tickets. Slip op. at 9-10. The City's distinction between past payments and future obligations is a line consistently drawn by courts between actions previously taken and those yet to come. The Court implied that to overturn the City's sewer-financing distinction would require overturning tax amnesty programs that are regularly used by governments.

The dissent, however, emphasized that the Court's analogy to typical amnesty programs was misplaced. "Amnesty programs are designed to entice those who are unlikely ever to pay their debts to come forward and pay at least a portion of what they owe." Dissent at 5. Because administrative convenience alone does not justify those programs, their constitutionality would not be in question.

The Court's decision continues the line of cases allowing under the Equal Protection Clause distinctions between taxpayers in forgiveness situations. As more states offer tax amnesty programs to increase tax revenues and encourage future compliance, they can feel secure that their programs should receive broad support from the courts, so long as they serve a rational purpose.

The question in Armour was summarized by Justice Breyer, the eventual author of the decision, near the close of oral argument as whether the City's choices were rational. To the majority of the Court – including, notably, Justice Thomas who broke with the conservative wing of the Court – found that administrative considerations alone can justify a tax-related distinction between taxpayers and a city's decision to stop collecting on certain assessments. Despite an invitation by the dissent, the Court refused to say "enough is enough" to continuing pressures on the Equal Protection Clause. The Supreme Court rarely grants certiorari to state tax cases, and the decision in Armour shows that taxpayers will continue to have an high burden when they do reach the courthouse steps.

Blair Ben small

Benjamin A. Blair, Esq. is a partner in the Indianapolis office of Faegre Baker Daniels, the Indiana 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.

 Paul Steve

Stephen H. Paul is a partner in the Indianapolis office of Faegre Baker Daniels, the Indiana 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..


Continue reading

Cost Approach Used to Determine Value of Taxable Property in Assisted Living Facilities Transaction

By Cris K. O'Neall, Esq., and Michael T. Lebeau, Esq.1, as published by IPT May 2011 Tax Report, May 2011

On January 6, 2011, the Assessment Appeals Board in Orange County, California issued a significant decision for owners and operators of assisted-living facilities, particularly facilities dedicated to providing "memory care" services. In a nutshell, the Board found that a significant portion of the assessed values enrolled by the Orange County Assessor's Office for memory care facilities acquired in 2007 included the value of non-taxable intangible assets and rights.2 The Board's decision not only demonstrated the correct handling of intangibles under California's property tax statutes, case law and State Board of Equalization guidance document, but also found that the cost approach should be used to extract non-taxable intangibles from business enterprise purchase prices in order to arrive at values for taxable real and personal property.

The Nature of Memory Care Facilities

Memory care is one of the fastest growing segments of the assisted-living care industry. Memory care facilities specialize in the housing and treatment of persons suffering from senile dementia, Alzheimer's disease, and similar "memory loss" maladies. Persons with these conditions typically suffer from moderate to severe memory loss. Consequently, the nature of the facilities that house persons with these conditions and the operation of those facilities differ from most other types of assisted-living facilities and operations.

In order to protect patients or residents from leaving the facility unattended or unescorted, memory care facilities incorporate design features which are not typically found in other types of assisted-living or even convalescent care facilities. The facilities must be laid out so that residents can be observed continually, and so that they do not wander away from the facility by themselves. Points of egress must be limited in number and must be designed to allow electronic monitoring at all times. Despite these severe design restrictions, the families of residents housed in memory care facilities usually want such facilities to have the ambience of a residential or home setting.

The operation of memory care facilities also requires significantly more staffing than the typical assisted living care facility. This includes additional nursing staff as well as staff to observe and work with residents.

There must be sufficient staff to monitor residents at all times in order to insure that they do not leave the facility unattended. In addition, because residents are typically ambulatory, a variety of planned on-site and off-site activities are usually provided to them, which requires a larger number of employees. This higher level of service requires a resident-to-staff ratio that is up to twice that for general assisted-living facilities, and a more skilled, better trained, and more highly paid management and employee staff than is typically found in other assisted-living situations.

Treatment of Intangibles under California's Acquisition-Based Property Tax Regime

California's Proposition 13 made acquisition prices the touchstone for taxable value in many instances. However, Proposition 13 did not explain what to do in those situations where an acquisition price includes a business enterprise comprised of real property, personal property and intangible assets and rights. Fortunately, California Revenue and Taxation Code sections 110(d)-(f) and 212(c) explain that intangible assets and rights are not taxable, and the values of identified intangibles must be excluded from the value allocated to a business enterprise in order to arrive at the value of taxable real and personal property. This is confirmed by published appellate court decisions such as GTE Sprint Communications Corp. v. County of Alameda (1994) 26 Cal.AppAth 992 as well as by the California State Board of Equalization's guidance in Assessors' Handbook Section 502, "Advanced Appraisal" (1998), Chapter 6, pages 150-165 ("Treatment of Intangible Assets and Rights"). Similarly, California Property Tax Rule 8(e) (18 Cal. Code Regs., § 8(e» requires that where a property is valued using the income approach, "sufficient income shall be excluded to provide a return on ... nontaxable operating assets."

Purchase Transaction Created Challenges for Purchaser

In early 2007, a number of memory care facilities and operations in several states, including four facilities and related operations in Orange County, California, were acquired by a large assisted-living facility operator.

The acquisition included not only the real and personal property at the four Orange County locations, but also the government-issued facility operating license, existing workforce, and business operating at each site. While the real and personal property were subject to property taxation, the purchaser contended that the facility operating licenses, workforce and other business-related assets (contracts, relationships, etc.) were not taxable under California law.

The transaction documents for the 2007 transaction did not assign a specific value to the various categories of assets (real property, personal property, and intangibles) for each of the Orange County locations. Fortunately, the seller of the properties had commissioned an appraisal for each of the properties.

Those appraisals were provided to the buyer, however, they were of limited utility in the property tax context because they were "going concern" appraisals which determined a business enterprise value for each facility and, therefore, included a value for all property at each of the Orange County facilities that encapsulated real and personal property as well as non-taxable intangibles. Furthermore, the buyer had used the going concern values shown in the appraisals as the basis for reporting the acquisitions to the Orange

County Assessor's Office and the Assessor's Office had simply enrolled the reported values as the taxable value for each property. Thus, there was a clear "chain" of documentation showing that the Assessor's Office had enrolled the value of all property, including intangible assets and rights, as the taxable value of the property at each facility.

The situation was further complicated by the fact that the purchaser had acquired the intangible assets (namely the operating licenses) through a saleleaseback arrangement and not through the purchase and sale agreement by which the real and personal property were transferred. This was done because a considerable amount of time is usually needed to transfer memory care facility licenses to a new owner, and waiting for the licenses to be transferred would have delayed the transaction for a year or more. Use of the sale-leaseback arrangement was typical in the industry, and had facilitated the transaction. The buyer's representative testified at the Assessment Appeals Board hearing that the buyer would not have acquired the four Orange County properties without the facility operating licenses as it would have taken too long to go through the process of obtaining new licenses. However, because the licenses had not transferred with the purchase and sale agreement, it created an impression that the buyer had not acquired the licenses, which were perhaps the most significant intangible asset in the transaction. On a positive note, the purchaser was helped by the fact that the seller's purchase appraisals exhibited the extreme disparities between the assessed values enrolled by the Assessor's Office (based on the income approach values) and the purchaser's values which relied on the cost approach: the Assessor's values were as high as $500 per square foot, several times the buyer's values for real property; the Assessor's values were also more than twice the cost new without depreciation for the improvements; and the Assessor's values were based on net income figures the majority of which were unrelated to the real estate at each location. All of this served to demonstrate that the Assessor's values subsumed the value of non-taxable intangible assets and rights in violation of California property tax law.

Cost Approach the Key to Taxable Values

The purchaser used the cost approach as the basis for proving the value of the taxable real and personal property. The purchaser retained the seller's appraiser, who had prepared the appraisals used to establish and allocate the total purchase price paid for all of the acquired facilities, to testify at the Assessment Appeals Board hearing. The appraiser explained that the appraisals were going concern appraisals, and for that reason the income and sales comparison approach values in those appraisals represented business enterprise values or the values of the going concern operating at each location.

The buyer's appraiser also testified that only the cost approach conclusions in the appraisals would represent the value of the taxable real and personal property. In support of this, the appraiser relied upon the Appraisal Institute's text The Appraisal of Nursing Facilities (J. Tellatin, 2009), particularly the portions of that text stating that "property tax assessments should exclude the value of intangible assets" and identifying intangible assets to include operating licenses and assembled workforce (pages 37, 40, 314, 315). The appraiser also focused the Board's attention on two key passages from the Appraisal Institute's text: The greatest usefulness of the cost approach could be in allocating the total assets of the business to real estate, tangible personal property, and intangible personal property assets under the theory that the value of an asset cannot exceed the cost to replace it in a timely manner, less reasonable amounts of depreciation. (Page 284)

When the depreciated cost of the tangible assets and the land are less than the overall business enterprise value, the cost approach can be a proxy for real estate value. (Page 315) These conclusions were supported by portions of the California State Board of Equalization's Assessors' Handbook Section 502 at page 159, note 126, and page 163: "The cost approach does not typically capture the value of intangible assets and rights because the appraisal unit only includes the subject property." With this background, the purchaser's appraiser demonstrated that the cost approach values in his appraisal report for each of the four facilities represented solely the values of the taxable tangible real and personal property.

The Assessment Appeals Board's Decision

The Orange County Assessment Appeals Board upheld the buyer's values, with adjustments for increased land values and minor increases in construction costs to account for inflation. The Board supported the buyer's position that the intangible assets and rights, particularly the operating licenses, had transferred along with the real and personal property as part of the same transaction: 42. The Board finds that the purchase agreement, the master lease, the sublease and a financing agreement that were all part of the same transaction, within the meaning of California Civil Code section 1642, and the purchase price did reflect and include intangible assets which are not subject to taxation.

Critical to this finding was testimony by the purchaser's representative that the payments under the lease agreements were not based on market rates, but were related to financing the transaction. In fact, evidence presented to the Board showed that the amount of each facility's lease payment exceeded or nearly exceeded the total revenue generated by each facility. Civil Code section 1642 provides that "several contracts relating to the same matters, between the same parties, and made as parts of substantially one transaction, are to be taken together."

The Board also ruled that the cost approach was the proper method for valuing the properties because it excluded the value of intangible assets and rights: 43. The Board finds that the cost approach is the most accurate measure of accurate [sic] value since the comparable sales approach and the income approach both captured the value of the property as a going concern and that it includes the value attributable to nontaxable assets and rights. Hence, the Board utilized the [cost approach portions of the] appraisals submitted by the Applicants as a starting point for its valuation analysis.

The Orange County Assessment Appeals Board's decision to use the cost approach, and to reject the income approach and sales comparison approach values from the buyer's going concern appraisals, affirmed Assessors' Handbook Section 502's counsel to avoid use of going concern appraisals (page 157) and to rely upon the cost approach when other approaches cannot segregate the value of taxable real and personal property from the value of intangible assets and rights. The Board's decision is a clear statement of the correct approach to be applied in the multi-facility purchase context in order to exclude the value of intangible property and determine the value of taxable real and personal property.

1. The authors acknowledge Max Row of Complex Property Advisors Corporation in Southlake, Texas and David H. Fryday of Tellatin, Short & Hansen, Inc. in Salem, Oregon for their comments and input to this article.

2. The facilities are owned by NorthStar Realty Finance.

Continue reading

American Property Tax Counsel

Recent Published Property Tax Articles

How to Fight Excessive Property Taxes During COVID-19

Cash-strapped municipalities may look to extract more revenue from commercial properties.

It would be difficult to conceive of a more impactful event for the commercial real estate market than the coronavirus pandemic. Short of finding a cure for COVID-19, the tremendous state of flux in the sector will test the resourcefulness...

Read more

Intangibles Are Exempt from Property Tax

Numbers of lawsuits remind taxpayers and assessors to exclude intangible assets from taxable real estate value.

A recent case involving a Disney Yacht and Beach Club Resort in Orange County, Florida demonstrates how significantly tax liability can differ when an assessor fails to exclude intangible assets. For Disney's property, the tax...

Read more

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...

Read more

Member Spotlight


Forgot your password? / Forgot your username?