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Aug
16

Property Taxation Runs Amok in the District of Columbia

"This pumping up of assessments allowed politicians the luxury of claiming that they did not raise the tax rate during the entire period. If taxes went up, even dramatically, well then that's just the marketplace talking."

By Stanley Fineman, Esq., as published by National Real Estate Investor Online - City Reviews, August 2011

Real estate taxes, which are based on assessor opinions, are the only subjectively determined taxes on the planet. And unlike other building expenses, which are largely controllable, property taxes are volatile, chaotic and often quixotic. Above all else, in the District of Columbia, they are high.

So, how high are your property taxes? Presumably all owners can answer that question on a cost-per-square-foot basis. But there are other perspectives to consider. How much have those taxes changed in the past five years? What percentage of the property's overall operating expenses do property taxes represent, and has that ratio altered over the years?

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Here in D.C., we keep track of such things — and the results are startling. Office building taxes ballooned from $4.97 per sq. ft. in 2004 to $8.81 per sq. ft. in 2009, an increase of 77%. That's more than double the rate of increase in office contract rents, which averaged $45.31 per sq. ft. in 2009, up 35% from $33.46 in 2004.

None of the tax increases in those five years resulted from changes in the millage rate, or tax per id="mce_marker",000 of valuation, which remained essentially constant for the entire period. The increase was the product of assessment legerdemain, and would have been much higher had property owners failed to wage relentless and successful administrative and judicial tax appeals.

This pumping up of assessments allowed politicians the luxury of claiming that they did not raise the tax rate during the entire period. If taxes went up, even dramatically, well then that's just the marketplace talking.

Never mind that the tax rate might have been significantly reduced, softening the blow of the assessment spikes, but it was not. After all, there were pet projects that needed feeding.

Economic toll

We can examine the impact of mushrooming assessed values on the bottom line. Non-tax building expenses including fixed costs, maintenance, utilities, administration and services rose modestly from 2004 through 2009, by perhaps 20%.

With tax bills growing at a faster rate, however, the tax burden as a percentage of total building costs increased dramatically over that same period.

By 2009, property taxes climbed to an astounding 42.25% of all operating expenses, up from 33.24% five years earlier. In the early 1990s, taxes were as low as 24% of all operating expenses.

The overall effect on property cash flow was to significantly blunt the profitability one might have expected from the general rise in property values over the period.

Let's examine that further. Average rental rates increased 35% over a five-year period. If property taxes had increased at the same rate, taxes on the average office building would be $6.71 per sq. ft.

But because property taxes actually climbed 77% over that five years, the average office taxes is $8.81 per sq. ft. That's $2.10 per sq. ft. lost from the bottom line.

In a 250,000 sq. ft. office building, not uncommon in D.C., that equates to a loss of $525,000, annually.

Let's now look at it from the perspective of the taxing authority. There are approximately 1,000 privately owned office buildings in D.C. If the average size were, say, 175,000 sq. ft., D.C. arguably would be gaining excess tax revenues approaching $400 million annually.

That is a staggering sum, a massive shift of the tax burden heaped quietly onto the shoulders of commercial owners.

The D.C. government, always a minority partner in real estate enterprises, has been biting off heftier chunks of the commercial pie through taxation as the years roll by.

This has allowed it to subsidize homeowners (i.e. voters) through reduced tax rates and capped increases. And everybody's happy. Oh, except commercial owners and their tenants, the geese that lay the golden eggs. And we all remember what happened to them.

A proposal

Over the years, commercial owners have raised many salient arguments in an attempt to hold down their taxes. For example, commercial taxes in D.C. are considerably higher than in the adjacent jurisdictions, suburban Maryland and Virginia, resulting in a competitive disadvantage for D.C. property owners.

Arguing this point has brought some success in lowering the D.C. tax rate, but a large disparity remains.

Most recently, recalcitrant D.C. assessors were slow to recognize the downturn in the economy that afflicted property values in all jurisdictions. When the economy improves, aggressive assessors will tend to be overzealous in pursuing and overstating the market.

Simply put, property taxes shouldn't increase at a faster rate than rents. In practice, such a rule would require first establishing a base line of rents and taxes, and then utilizing reliable data to establish increases.

There might be lag time involved in acquiring and utilizing the data, but that challenge is a hill, not a mountain, to climb. And most importantly, it would be reasonable and fair.

sfinemanStanley J. Fineman is a shareholder in the law firm of Wilkes Artis Chartered, the District of Columbia 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.

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Jul
27

Oklahoma Courts Rule Low-Income Housing Tax Credits Shouldn't Be Treated As Property Income

"A developer who commits to operate a property as a low-income housing complex can apply for Low Income Housing Tax Credits under Section 42 of the Internal Revenue Code. The developer then sells the credits to investors to generate equity to construct the project..."

By William K. Elias, Esq., as published by National Real Estate Investor - Online Edition, July 2011

The impact of low-income housing tax credits (LIHTC) on the taxable value of real property has been a subject of controversy in Oklahoma for many years. A recent court ruling lays down the law, however, by definitively excluding the credits from calculations of taxable value.

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Under the Tax Reform Act of 1986, Congress established the low-income housing tax credit program to encourage private development of affordable housing for people with low incomes.

A developer who commits to operate a property as a low-income housing complex can apply for Low Income Housing Tax Credits under Section 42 of the Internal Revenue Code. The developer then sells the credits to investors to generate equity to construct the project.

The recent case of Stillwater Housing Associates v. Jacquie Rose, Payne County Assessor, et al. (Oklahoma Supreme Court No. 108,682) could result in lower tax assessments for many low-income housing properties in Oklahoma.

In the Stillwater Housing decision, the Oklahoma Court of Civil Appeals issued several conclusions to clarify how low-income housing tax credits issued under Section 42 of the Internal Revenue Code affect taxable value.

Case in point

The Stillwater Housing case arose in Payne County, Okla., where limited partnership Stillwater Housing Associates applied to the Oklahoma Housing Finance Agency for low-income housing tax credits to develop a low-income housing complex. The agency granted credits to be allocated over 10 years in the amount of $455,235 per year.

To generate private equity to complete construction, Stillwater sold its low-income housing tax credits to investors, who became limited partners, and the credits flowed through Stillwater directly to those limited partners. Stillwater received no monetary benefit or cash flow from the tax credits.

Stillwater was obligated under a regulatory agreement to rent the units to low-income residents at restricted rents for 40 years. The tax credits were subject to recapture if Stillwater breached the terms of the regulatory agreement during the first 15 years.

Under Oklahoma law, real property is assessed annually as of Jan. 1 at its fair cash value. That's the estimated price the property would bring in a voluntary sale for the highest and best use for which it is actually used, or classified for use, during the previous calendar year.

Assessors can use the cost, income or sales-comparison method to estimate fair cash value. Neither the Oklahoma statutes nor the Oklahoma Tax Commission rules prescribe a methodology for valuing low-income housing tax credit properties.

In 2007, Stillwater protested the assessor's value of the property and asserted a fair cash value of $3.975 million, based upon actual rents. The assessor denied the protest and the developer appealed to the County Board of Equalization. The board instructed the assessor to add $235,347 of tax credits as income under the income approach. As a result, the value increased to more than $8.6 million.

Stillwater appealed the board's value to district court and both sides filed motions for partial summary judgment on the issue of whether low-income housing tax credits should be treated as property income. The district court ruled in favor of Stillwater and the assessor appealed.

The Oklahoma Court of Appeals affirmed the district court, however, and held that low-income housing tax credits are not income and do not replace income to the real property.

The court also held that the credits are tax benefits belonging to the investor, not a right or privilege belonging to the land, meaning the credits are not within the statutory definition of real property. Finally, the court held that the tax credits are intangibles exempt from taxation under Article X, Section 6A of the Oklahoma Constitution.

The assessor asked the Oklahoma Supreme Court to review the appeals court decision, but that petition was denied on March 28, 2011. When published, the appellate court's Stillwater Housing decision will constitute persuasive authority in all Oklahoma courts.

What does Stillwater Housing mean for owners of low-income housing tax credit properties? First, because the tax credits are not income and do not replace income to the property, the credits must be excluded from income-based assessments.

Second, because the credits are tax benefits belonging to the investor and not a right or privilege belonging to the land, then credits do not fall within Oklahoma's statutory definition of real property.

Essentially, regardless of their value to investors, low-income housing tax credits are intangibles exempt from taxation. The Stillwater Housing decision could result in lower tax assessments for many LIHTC properties in Oklahoma.

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William K. Elias is a partner in the Oklahoma City law firm of Elias, Books, Brown and Nelson, P.C., the Oklahoma member of American Property Tax Counsel (APTC). He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jul
06

The Adventures of Valuation

The unique characteristics of a low-income housing tax credit project make it difficult for assessors to apply standard market value definitions and approaches in making a fair assessment.

By Stewart L. Mandell, Esq., as published by Commercial Property Executive, July 2011

Can you visualize how your tax appeal attorney would address an assessor's sales-comparison based property valuation? What if your attorney were Sherlock Holmes? Holmes sits at his desk as Watson enters. "Holmes, old boy, look at the assessor's valuation report on the Franklin Office Center, a multi-tenant office building. The assessor's fl awed cost approach is no surprise, but who would have expected a comparable-sales analysis with five sales to justify a sky-high value as of Jan. 1, 2010?"

Holmes chuckles as he quickly digests the report. "There is nothing here that should trouble you, my dear friend. Our evidence and my cross examination of the assessor will result in a compelling closing argument and a sizable assessment reduction."

"You already know how you'll address these sales?" asks Watson with astonishment.

"Why, of course," says Holmes, rising. "Here's how I'll summarize this in my closing statement: Your Honor, Sale No. 1 obviously is not a valid comparable, given the October 2007 date of sale. As our appraiser testified, from the market's peak in October of 2007 until January 2010, office building values in the area declined more than 40 percent. "You could make a market condition or time adjustment for that reason, and it would be something in excess of 40 percent. But the sale should be rejected because 2007 market conditions were so extremely different from what existed on Jan. 1, 2010. This sale is no more useful than one where the seller exercises an option to buy that was part of a lease agreement negotiated five years earlier."

Selecting his favorite meerschaum from the mantelpiece, Holmes continues: "Sale No. 2 must be rejected on the same grounds as Sale

1. Initially, the assessor made much of the fact that this sale closed on Sept. 16, 2008, which was after the start of the Great Recession, the Bear Stearns collapse and Lehman Brothers' bankruptcy filing.

"On cross examination, however, the assessor admitted that the parties executed the purchase agreement on March 7, 2008. That was well before both the valuation date and the point when the values of offi ce buildings plunged like Professor Moriarty descending the falls at Reichenbach." Having filled his pipe, Holmes turns toward the window.

"Sale No. 3 is irrelevant," he resumes. "Oh, it closed during the last quarter of 2009, near our valuation date, but there is one detail the assessor overlooked: This property was 100 percent leased to one of the 10 largest companies in the country, with 10 years remaining on the lease term. The assessor valued the landlord's interest, also known as the leased fee, and not the fee simple interest. The rent that produced this sizable sale price is well above Jan. 1, 2010, market rents. And in our state, valuation using a leased fee interest and above-market rents is unlawful." The strike of a match punctuates this last revelation.

"Sale No. 4 not only shares the fatal fl aw of Sale 3, but is even less defensible because it is a sale of a leased, built-to-suit property. Here, one of the country's most successful companies had arranged for construction of a facility to its exact specifications, and ultimately an investor acquired not just the property but also the tenant's 35-year lease.

"Of course, the rent is based on the contractor's cost and is unrelated to current market conditions. Not only was the transaction purely financial but as our appraiser's empirical data showed, built-to-suit properties such as this include significant costs that will not increase the property's sale price when subsequently sold." The atmosphere in the room begins to resemble the fog outside the window.

"Sale No. 5 is a sale-leaseback transaction. Town of Cunningham v. Property Tax Appeal Board, a 1992 Appellate Court of Illinois decision, is one of a number of decisions that confirm why this sale is irrelevant. "In the Cunningham case, the property owner initially listed the property with a sale price of $6 million, as well as a leaseback provision that would pay annual rent ranging from $200,000 to $250,000 for a term of 10 to 15 years. Ultimately, the property sold for $9.3 million plus a 15-year leaseback, with annual rent at $615,000. Obviously, the sale price and lease terms were directly related, with a higher rental stream producing a higher sale price. As the court concluded, this was a financing transaction, and the purchase price was unrelated to the property's market value."

Holmes bends to address his companion, seated beneath the swirling cloud. "In short, Your Honor, the assessor's sales-comparison approach is not worth the paper on which it is written."

Clearly, if owners are to achieve fair property tax valuations, they and their attorneys must dig deeply into comparables used by assessors. And that is elementary.

MandellPhoto90Stewart L. Mandell is a partner in the Michigan law firm 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.

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May
18

Weighing the Value of Valuation Methods

"Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method."

By Stephen H. Paul, Esq., as published by Commercial Property Executive Blog - May 2011

Appraisers can choose from three approaches to determine what a buyer would pay for a commercial property. But which approach is the most appropriate method of valuation?

The cost approach assumes that buyers will pay no more for a property than it would cost them to build an equal substitute. The appraiser calculates the cost to build the property and subtracts physical, economic, and functional depreciation.

Appraisers prefer this approach for newer properties that lack an operating history. The cost approach is also preferred for unique or specialty properties because no comparable properties may exist.

The income approach assumes that buyers will pay no more for the commercial real estate being assessed than it would cost to purchase an equally-desirable, substitute investment. The appraiser calculates the net income from the property over a given number of years, and discounts the result to its present value.

Appraisers prefer the income approach for income-producing properties that are typically bought and sold by investors. However, this approach requires accuracy in setting the interest rate and predicting future expenses.

The sales approach assumes that buyers will pay no more for the property than it would cost them to purchase an equal substitute. The appraiser locates sales of comparable properties and adjusts the prices to reflect the subject property. Although this approach may be the most accurate in that it provides a price in a particular market, finding a truly comparable property can sometimes be difficult.

Whichever approach or combination of approaches is used, the value of a property should never be higher than that calculated under the cost method. A buyer would not pay more for a property than it would cost to build, unless something else was included in the value. Anything above the value given by the cost approach must be business value, which is excluded from value calculations for property tax purposes.

PaulPhoto90Stephen H. Paul is a partner in the Indianapolis office of Baker & Daniels LLP, 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..

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May
18

Tax Grab: Are New York Assessors Inflating Values for the Wrong Reasons?

"The real estate tax is based on the tax rate and a property's assessed value. In the face of all the troubles and distress seen in real estate over the last three years, the City of New York has made some outsized increases in its estimates of market values, which it uses to assess properties for taxation..."

By Joel R. Marcus, Esq., as published by National Real Estate Investor, April 2011

The New York City real estate community has been through the wringer since 2007. It has endured a dearth of major property transactions, suffered through the meltdown of the financial services industry and watched available debt financing evaporate. Lenders and special servicers are more in control of the real estate market than ever before.

In the real world of property ownership and development, many taxpayers are experiencing a drop in occupancy for office, hotels and rental apartment buildings. Condo sales have slowed to a trickle and construction of new office, hotels and apartment buildings has come to a virtual standstill.

In this environment of dropping office rents, condominium fire sales and increasing costs of operations, real estate taxes — the largest component of a building's expenses — have skyrocketed. Why is this happening?

New York City satisfies its budget needs through a variety of taxes, and of all of them, the real estate tax is the most important and durable. The city now finds itself facing a cutback in state and federal aid and has big budget deficits. This is happening at a time when corporate and personal income taxes and sales taxes have declined, and other taxes such as transfer and mortgage-recording taxes have all but disappeared.

The city's revenue options are few. People and businesses can move to New Jersey or other areas to escape New York City's income taxes or sales taxes, and this puts a practical limit on what New York City can extract. Real estate, however, is stuck in New York City and can't escape the city's tax grip.

Excessive taxes erode equity.

The real estate tax is based on the tax rate and a property's assessed value. In the face of all the troubles and distress seen in real estate over the last three years, the City of New York has made some outsized increases in its estimates of market values, which it uses to assess properties for taxation.

A snapshot provided by the City of New York Department of Finance highlights some of these amazing hikes in estimated market value. In Queens, for instance, assessors raised the market values for cooperatives 32.37% (on average12.05% citywide) from last year and Queens luxury hotels experienced a 27.97% increase as well. Manhattan luxury hotels underwent a 14.82% raise in values, while values climbed 9.65% for cooperatives and 15.91% for condominiums.

Many in the commercial real estate industry believe that the jump in assessed real estate market values is related to the city's budget woes, rather than to actual changes in the market place. The city vociferously denies this notion, but as Shakespeare's Hamlet said, "The lady doth protest too much, methinks."

How much tax is too much?

An analysis of the city's system for assessing properties shows that in office and other commercial properties the property tax bite consumes almost 34% of a property's pre-tax net income. Let's examine with this hypothetical example the formulas used by assessors.

An office building charges $45 rent per sq. ft. Its operating expenses are $12 per sq. ft., and its amortized leasing and tenant expenses are another $4.50 per sq. ft. Therefore the pre-tax net income is $28.50 per sq. ft.

The city divides that income by 13.64%, which is derived by adding a 9% capitalization rate to 4.64%, or 45% of the 10.312% tax rate. That yields a fair market value of $209 per sq. ft.

Assessed at 45% of fair market value, the result is a tax assessment of $94 per sq. ft. and a tax bill of $9.70 per sq. ft., based on the 10.312% tax rate. Therefore the city is a partner in 34% of the net operating income without any equity investment at all! This is before debt service, depreciation and capital improvements are accounted for — expenses that only the owner has to pay but for which the owner gets no credit from the city. Not bad if you can get away with it.

For apartment buildings, the pattern is even more egregious. If rents are $45 per sq. ft. and expenses are $12 per sq. ft. as in the office example, the assessor takes 45% of the 13.353% Class-2 tax rate (which is 6.009%) and adds a 7.5% cap rate to get a loaded cap rate of 13.509%. Divide the cap rate into the net operating income of $33, and the fair market value is $244.28 per sq. ft.

The assessment, therefore, is $110 per sq. ft., and this applies to the tax rate results in annual taxes of $14.69 per sq. ft. That's 44.5% of the property's pre-tax net income. Boy, what a deal the city has! If major capital repairs are needed for such expenses as the facade or elevator modernization, a roof or an apartment makeover, they are borne solely by the owner. None of these expenses are factored into the city's formula.

Property owners can always appeal their assessments, but many believe that it's the city's policy on taxes instead, that needs a reassessment.

MarcusPhoto290Joel R. Marcus is a partner in the law firm of Marcus & Pollack LLP, the New York City 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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May
09

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.

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May
05

A Growing Dilemma Over Tax Abatements

"States struggle to keep economic development incentives viable amid budget tightening...."

By Darlene Sullivan, Esq., CMI., as published by National Real Estate Investor, May 2011

Policy makers have long used property tax abatements and incentives to draw investment, rehabilitation and other economic development to particular locations. While the economic effects of abatements and incentives are typically positive, officials facing budget deficits at state and local levels have begun to look for ways to hold onto more of their potential tax revenues while still enticing new business and development.

It is a difficult balancing act for lawmakers, and the changes they seek vary by state. For property owners and developers considering construction, expansion, or renovation of a new facility, now is the time to study any proposed changes to incentive rules and to ensure compliance with existing incentive agreements.

In Texas, state legislators are considering revisions to several economic development incentives the state has successfully used to attract new companies. Lee Higgins, president of Austin-based Business Economic Incentives LLC, fears that a major overhaul of business incentives offered by the state would slow economic growth in the state.

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Smaller steps

To counterbalance a potential slowdown in economic growth in North Carolina, state officials are working to find ways to support projects that would not have qualified for state or local government support before the economic downturn.

For instance, in better times, companies typically would have to create 50 to 100 jobs and commit to invest $2 million to $5 million in capital expenditures before a state or local agency would show much interest in supporting a project.

Now, a company can create as few as 20 new jobs and spend less than $1 million on capital improvements and still gain the support of local government.

In addition, economic development officials in North Carolina have shown flexibility and a willingness to discuss support for projects that entice existing employers to remain in the region, especially as companies are in the process of consolidating operations across the U.S.

In North Carolina, Gov. Bev Purdue schedules public announcements when companies add as few as 15 new jobs to show her commitment to economic development, says Craig Fisher, managing member in the Charlotte, N.C. office of Tax Incentives Consultants LLC.

Many state and local economic development officials are working with companies struggling to meet job creation numbers agreed to before the slump.

Flexible programs

In the Northeast, the economic downturn has limited the amount of incentives that states can offer, but government officials have been granted freedom to exercise more creativity with programs that promote economic development.

In Massachusetts, the Economic Development Incentive Program offers a negotiated state investment tax credit and municipal tax increment financing. Once highly utilized, the program has been capped at $25 million annually as of Jan. 1, 2010.

Massachusetts has increased flexibility for the investment tax credit to equal as much as 10% of construction and start-up costs for projects in locations designated for economic development. In areas of Massachusetts not designated as economic target areas, a project that creates 100 or more jobs also is eligible to receive a 10% investment tax credit.

Scot Butcher, managing member in the Boston office of Tax Incentives Consultants LLC, says the tax credit amount may be taken as credit against future taxes or collected as a refund. The tax credit can run as high as 40% for some manufacturing projects.

The trends in Texas, Massachusetts and North Carolina signify that tax abatements and incentives are still available to property owners. To take advantage of abatement laws in their region, owners need to understand the laws governing them and stay abreast of the changes that have occurred in these laws.

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Darlene Sullivan is a partner with the Austin law firm of Popp, Gray & Hutcheson LLP, the Texas member of the American Property Tax Counsel (APTC). She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Apr
24

The Pitfalls of Sales Comparisons

"By overlooking seller financing, assessors inflate taxable values..."

By Michael Shalley - as published by National Real Estate Investor - April 2010

It's no secret that commercial real estate sales volume is down. Sales transactions of U.S. commercial real estate valued at $5 million or more totaled 3,336 for all of 2009, down 60% from the previous year, according to Real Capital Analytics (RCA).

Despite more stringent underwriting and a growing reluctance by lenders to make commercial real estate loans, buyers and sellers closed a few select deals. Today, tax assessors are using those sales as a basis to value property for 2010.

Improper conclusions by tax assessors based on these imperfect sales could result in excessive values on which property tax assessments will be based.

Only 15% of U.S. property transactions last year represented a distressed situation, but the year's deals typically reflected a decline in value from highs of the preceding five years.

Due to the scarcity of credit available for real estate purchases, assumable mortgages and seller financing emerged as the dominant means of closing transactions in 2009, according to RCA. That means that many of the past year's deals closed without the use of market-rate loans that would have pushed down closing prices.

True market value?

The prevalence of those significant price reductions, mortgage assumptions and seller financing in 2009 sales data poses a challenge for appraisers and tax assessors, and a threat to taxpayers.

If not properly adjusted for in a sales comparison approach to valuing property, these same three factors that sellers used to bolster sales may understate how far actual market values have declined.

Special financing or sales concessions often characterize transactions in depressed markets. Understanding the details behind each transaction is important for establishing a credible sales comparison approach to value at any time, but it becomes absolutely critical during volatile periods with few sales.

Suppose an assessor valuing office buildings for his tax district believes that most property values have declined, but he has a limited number of transactions to determine market value. In a review of recent sales, he sees that a 100,000 sq. ft. office building has sold for a reported $10 million, or $100 per sq. ft.

The same property sold five years ago for $12 million, or $120 per sq. ft. With no further investigation of the transaction details, the assessor concludes that office building values in the neighborhood have declined 17% in five years and are now trading at $100 per sq. ft.

The devil is in the details

On its face, the assessor's conclusion appears reasonable, but with depressed markets we must dig deeper into the details of every transaction. In this example, the use of seller financing reveals a market value that is significantly lower than the $10 million transaction price would lead us to believe.

Assume the seller provides a higher loan-to-value ratio and lower interest rate than what the market offers. This props up the sale price by $1 million.

Adjusting the sale price for below-market financing, you arrive at a market value of $9 million, or $90 per sq. ft. That represents a 25% decline, as opposed to the assessor's 17% calculation.

As RCA reported, seller financing has become one of the primary alternatives to new loans, and it usually provides below-market financing terms for the buyer. Additionally, it provides the seller with a continued investment in real estate and avoids the need for a redeployment of capital into alternative investments.

Assessors are bound by the Uniform Standards of Appraisal Practice, which require an appraiser to address whether financing terms are at, below, or above market interest rates. The assessor also must determine whether a sale reflects unusual conditions, terms, or incentives.

Most sales closed today have a story behind the deal. By uncovering the details of each transaction, you might find that an adjustment is necessary to arrive at a true market value, and those details will give you a stronger case to present to the assessor in seeking a reassessment.

ShalleyMichael Shalley is director of appeals at the Austin law firm of Popp, Gray & Hutcheson, the Texas 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..

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Apr
18

Real Estate and the Yankees

Why Hotels and Nursing Homes Prove Especially Vulnerable to Inaccurate Taxation

"The most valuable asset the team would acquire through that contract would be a continued association with the Derek Jeter name, a brand in which the team has invested a great deal. The Yankees' challenge in reaching a new contract with Jeter, recently accomplished, indeed echoes the difficulty faced by many municipal assessors in valuing properties that are as much business as they are parcels of real estate."

By Elliott B. Pollack, Esq., as published by Commercial Property Executive, April 2011

Tax laws across the United States typically prohibit assessors from including intangible assets such as good will, franchise value or business value in a property tax assessment. Only tangible real and personal property may be placed on assessment rolls. But taxpayers and assessors alike sometimes have difficulty differentiating between tangibles and intangibles.

That's understandable on the part of taxpayers who may need to include intangibles in their calculations when buying or selling a hotel, nursing home or assisted-care property. For purposes other than property taxes, intangibles often are part of a property's overall value. Indeed, rivers of ink in appraisal and valuation literature—not to mention judicial rulings— have been devoted to the issue of intangibles.

Unfortunately, many assessors don't fully understand how to exclude these non-taxable elements from their calculations, either. For the unwary property owner, the resulting overassessment can result in an equally overstated tax bill. One way to gain a clearer perspective on the degree to which intangible assets can affect value is to turn our lenses on another field entirely—a baseball field, in fact. On Nov. 10, 2010, sports columnist Richard Sandomir presented an illuminating look at the talents of the New York Yankees' redoubtable shortstop, Derek Jeter, in an article for the New York Times. "The Yankees would not quite be the Yankees if (Derek Jeter) suited up with another team," Sandomir noted. The writer contended that Jeter adds substantially to the Yankees' overall value, much in the same way, it can be argued, that a respected brand boosts the worth of a hotel. Without Jeter's headline-grabbing performances, the team would be less valuable, just as an unflagged hotel is likely to be less valuable than its branded competitor. Sandomir quoted a business consultant who observed that Jeter's playing, were he less celebrated, might be worth $10 million a year. But as an iconic draw for ticket sales, Jeter's value to the team is closer to $20 million each year. The Yankee captain's "value as a brand builder," the expert noted, not merely as a hitter or infielder, is what drives his intangible worth differential, again, very much like the business value inherent in a well-managed hotel or convalescent facility.

With Jeter's lengthy contract concluded, it would be foolish for the Yankees not to sign him up again as he enters free agency, even though his baseball skills have eroded, the expert opined. The most valuable asset the team would acquire through that contract would be a continued association with the Derek Jeter name, a brand in which the team has invested a great deal. The Yankees' challenge in reaching a new contract with Jeter, recently accomplished, indeed echoes the difficulty faced by many municipal assessors in valuing properties that are as much business as they are parcels of real estate.

After years of resistance from taxpayers and their attorneys, it seems taxing authorities in the United States are getting the message about intangible assets. It now appears that the majority of assessors recognize that the net operating income generated by a hotel, as an example, does not result exclusively from its real estate value. In fact, the management expertise—which drives revenues from non-occupancy hospitality services such as food service, special events and recreation revenues—is an asset independent of and severable from the real estate itself.

Similarly, the intensive services furnished to the patients of long-term-care convalescent facilities are distinct from the property in which those services operate. Indeed, nursing and medical care, meals and rehabilitation produce revenues that have little to do with the real property and should not be capitalized when the health-care facility is valued using an income methodology.

There is case law to provide examples of the correct way to value commercial real estate without inflating taxable value by rolling intangible assets into the equation. Taxpayers interested in doing a little research will find one court's approach toward the separation of intangibles and the valuation of health-care real property in the case of Avon Realty L.L.C. v. Town of Avon, decided in 2006 by the Superior Court of Connecticut, Judicial District of New Britain. In that case, the owner of the Avon Convalescent Home, a 120-bed skilled nursing facility, appealed an assessed value in excess of $5 million on the grounds that the assessor hadn't deducted sufficient value attributable to intangible assets from the business's overall value. Upon review, the court deemed the value to be a little more than $4 million, supporting the taxpayer's appeal.

A thorough understanding of the issues and methodologies involved in properly differentiating and valuing tangibles and intangibles marks the difference between fair and excessive property tax assessments for hotels, nursing homes and assisted-care facilities.

 

Pollack_Headshot150pxElliott B. Pollack is chair of the property valuation department of the Connecticut law firm Pullman & Comley L.L.C. He cautions that he is an avid Boston Red Sox fan. The firm is the Connecticut 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..

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Apr
18

Taxes Target Green Pastures

"Property owners must stay vigilant to maintain agricultural-use status on farmland and avoid financial penalties..."

By Douglas S. John, Esq., as published by National Real Estate Investor, April 2011

Local governments are under the greatest financial stress since the Great Depression, and assessing authorities are aggressively pursuing revenue to combat these financial woes. One target in assessors' crosshairs is the preferential tax treatment of land with agricultural status.

Developers who are considering the purchase of agricultural land or holding acreage for eventual development need to be aware of the potential tax consequences. Depending on the way assessors categorize the land, the owner could face an unexpected rise in tax costs.

All states offer some tax relief for qualified agricultural property, but each jurisdiction has specific and often complex legal requirements for agricultural status. Investors in land held for future development must know the laws governing agricultural status if they hope to maintain this preferred tax position.

Most real estate is assessed at market value, which typically reflects the most probable price a buyer would pay in a competitive market. The most common benefit of an agricultural designation is that the land is assessed at use value instead of market value. Use value reflects how the property is currently used, i.e., for agriculture, rather than its highest and best use, which may be for residential or commercial development.

Eligibility for agricultural status varies by jurisdiction. The following are the major eligibility requirements.

  • Use: Typically, states require that land be actively engaged in agricultural use and used exclusively or primarily for commercial agriculture. That can include growing crops, dairying, raising and breeding livestock, or horticulture.
  • Acreage: A majority of states impose an acreage requirement to qualify for agricultural use, meaning a minimum number of acres. Qualifying acreage is typically low relative to average farm size. Some states have no minimum acreage requirement, while others allow local authorities to establish size criteria.
  • Productivity: Most states impose minimum productivity requirements. These laws vary by jurisdiction, but most require property to generate a minimum amount of annual income from farming or raising livestock. Some states average the measure of income over a period of years. Other states require that a minimum percentage of the owner's or lessee's annual income is earned from agricultural activity on the land.
  • Prior Usage: About half the states require property to be used for agricultural purposes for a period of years before it qualifies for preferential tax treatment. These laws are meant to discourage owners from changing a tract's use to take advantage of the tax benefits. Two or three years immediately preceding approval is typical.

Check for penalties

Many states impose a penalty when farmland is converted to non-agricultural use. In some states the penalty takes the form of a recapture or rollback tax, which is the difference between the taxes that would have been paid and the taxes actually paid while the land qualified as agricultural. This recapture period varies between three and 10 years.

In other states, if farmland is converted from agricultural use within a certain period after qualifying for preferential treatment, penalties are calculated based on the property's fair market value when its use changes or it is sold.

Most states require owners to periodically submit extensive information to demonstrate that the land continues to be used agriculturally. This may include IRS Form 1040F, leases, invoices and receipts, among other documents.

Each state's eligibility requirements, application process and potential penalties play a part in determining whether properties qualify for agricultural status. But a property's agricultural status can translate into significant tax savings. Local counsel may be required to navigate the complexity of obtaining or maintaining the agricultural status.

Douglas S. John is with the Tucson, Arziona law firm of Bancroft Susa & Galloway, the Nevada and Arizona 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..

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