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May
25

Property Tax Tip: Beware of Misleading Comp Sales

Are you challenging an assessment?  

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

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

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

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

FINDING THE MOTIVE

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

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

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

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

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

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

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

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

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

 

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

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May
01

IPT's 2017 Property Tax Article of the Year

The Institute for Professionals in Taxation has awarded Brent A. Auberry, Esq., Stewart L. Mandell, Esq., and Daniel L. Stanley, Esq. with the 2017 Property Tax Article of the Year Award for their article entitled, “Invalid “Dark Box” Property Tax Claims Misinform Indiana and Michigan Legislatures,” which was published in the July 2016 issue of IPT’s monthly publication, IPT Insider.

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May
01

Invalid "Dark Box" Property Tax Claims Misinform Indiana and Michigan Legislatures

Some have recently called this the dark box theory. However, what some are now calling the dark box theory is simply traditional accepted valuation methodology. Indeed, among appraisal professionals, it is the use of comparable sales of occupied stores that generates controversy and is often inappropriate to value an owner-occupied store.

If the criticisms of valid appraisal methodology are not legitimate, why has this issue received so much attention? One cause is the financial pressure on localities due to lower property values from the Great Recession. Not only did property values fall after 2008, but many businesses closed altogether. Communities have faced not only a loss in jobs but also decreasing property values. In both Michigan and Indiana, that pressure was compounded by the application of property tax caps. Public coffers to support local services have been squeezed, and state governments have not provided additional funding.

Another root cause was self-inflicted: the unjustified, over-assessment of new big box stores. Assessors used construction costs and land cost as the “market value” of the property, despite the fact that, like a new car or a newly tailored suit, the market value of these properties is always less than the cost of construction.

The purported problem is also one of public perception. If a retail store is operating, with inventory on the shelves and customers in the aisles, it may be difficult for the general public and local officials to understand why it is appropriate to value the property by using a transaction of a similar store that was vacant at the time of sale.

Trained assessors, however, should know better. They are legally required to only value the property itself, i.e., its “sticks and bricks” as well as the land. The occupants and content of the property have no relevance to the market value of an owner-occupied real property. Most states separately tax the business activity conducted on a property through income and sales taxes. Assigning value to property based on a taxpayer’s business operations will unlawfully tax properties based on both intangible assets and intangible factors, and result in nonuniform taxation of similar properties.

Indiana Board of Tax Review Decisions
In December of 2014, the Indiana Board of Tax Review (IBTR) issued two opinions, which in most respects were no different than hundreds of rulings that preceded them.In both cases, taxpayers prevailed after the IBTR concluded their USPAP-compliant appraisals represented the best evidence of value. In the first case, involving a freestanding 237,000 square foot big box store in Indianapolis, the taxpayer’s appraiser developed and relied upon the sales comparison and income approaches to value (assigning more weight to the sales approach) to reach value conclusions for multiple tax years. In the second case, involving an 88,000 square foot big box store attached to a shopping center, the taxpayer’s appraiser developed all three approaches to value but relied on and assigned equal weight to the sales comparison and income approaches to value.

In both cases, the taxpayers’ appraisers used sales of vacant stores. Each appraiser adjusted those sales to reflect the differences between the appraised store and the comparable stores. Neither appraiser relied exclusively on the sales comparison approach to value. Consequently, the IBTR’s rulings in both appeals were not based solely on the supposed “dark box” sales, and the sales that were relied upon were adjusted to reflect differences between the subject and the comparable properties, with respect to physical condition, location and other factors.

That nuance was lost on the assessing community as a whole and the subsequent statewide media reporting. The public was told that the IBTR incorrectly compared an active store with a defunct one. Yet, a sale of a vacant store represents the transfer of the real property alone, without the value of the business operations, which is exactly what should be valued under the law. The flawed and overly simple criticisms of the IBTR’s decisions were repeated often, and loudly. Unfortunately, the Indiana General Assembly listened.

The Indiana Legislative Reaction and its Subsequent Fallout 2015 Legislation
After much heated discussion, the Indiana legislature, in the waning hours of its 2015 session, passed two provisions addressing “dark box” assessments in Senate Bill 436. The first provision (Section 43) was directed at big box stores. Assessors were directed to assess newer stores (those with an effective age of ten years or less) using a modified cost approach, accounting for physical depreciation and obsolescence.

The second provision (Section 44) impacted all “commercial non-income producing real property, including a saleleaseback property.” In determining the true tax value of qualifying properties with improvements with an effective age of ten years or less, a “comparable real property sale” could not be used if the comparable, among other restrictions, had been vacant for more than one year as of the assessment date.

Sections 43 and 44 were not well received. The IBTR issued a memo noting the new law contained “provisions that run counter to generally accepted appraisal practices.”

2016 Legislation
Indiana’s 2016 legislation session saw a complete repeal of Sections 43 and 44, effective January 1, 2016. House Bill 1290, Section 13, added Ind. Code § 6-1.1- 31-6(d) to provide: “With respect to the assessment of an improved property, a valuation does not reflect the true tax value of the improved property if the purportedly comparable sale properties supporting the valuation have a different market or submarket than the current use of the improved property, based on a market segmentation analysis.” Any such analysis “must be conducted in conformity with generally accepted appraisal principles.” And the analysis “is not limited to the categories of markets and submarkets enumerated in the rules or guidance materials adopted” by Indiana’s property tax rulemaking agency, the Department of Local Government Finance (DLGF), which is the agency that was directed to develop rules classifying improvements in part based on market segmentation.

What does this mean? That remains to be seen. Subsection 6(d) will undoubtedly be litigated before the IBTR and Indiana Tax Court, and the DLGF is in the process of developing its market segmentation rules. We do know two things: (i) the party challenging use of comparable sales must provide the market segmentation analysis; and (ii) the analysis must be based on generally accepted appraisal principles. No presumption exists under the statute that a sale is excluded. Exclusion must be proven with expert analysis.

Subsection 6(d) will lead to more costly appeals, with additional expert testimony and reports on market segmentation being required. As appeal expenses increase, litigants are likely to adopt tougher settlement positions, which will cause fewer cases to settle. As litigation takes longer to resolve, local officials’ uncertainty regarding the tax base will also increase. Section 13 also added Ind. Code § 6-1.1- 31-6(e), which cemented a long-standing principle of Indiana assessment law, i.e., that true tax value “does not mean the value of the property to the user.” To illustrate, the assessed value of a big box store owned and operated by Wal-Mart cannot be based on the specific value that the store has to Wal-Mart due to, for example, how Wal-Mart uses its unique marketing and employee training standards to sell its distinctive product mix.

Proposed Michigan Legislation – HB 5578
As in Indiana, Michigan government representatives have been waging a public relations campaign that has misled the public, including policy makers. The legislation drafts originally circulated were influenced by Indiana’s legislation. Ultimately, on June 8, 2016, the Michigan House passed House Bill 5578 (“HB 5578”). Among its many significant flaws, HB 5578 prevents use of the sales comparison approach in cases where its use would be appropriate, and forces reliance on the cost approach, without accounting for all forms of obsolescence. It is not yet known what will happen to the bill in the Michigan Senate.

HB 5578’s Required Findings of Fact
HB 5578 requires many specific findings of fact by the Michigan Tax Tribunal in a tax assessment appeal. Among others, HB 5578 requires specific findings of fact regarding: the market in which the subject property competes, the highest and best use of the property under appeal, the reproduction or replacement cost, and comparable properties in the market that have the same highest and best use.

While the listed factors are appropriate to consider in a valuation appeal, requiring specific findings of fact will be extremely burdensome and, in some cases, is ambiguous or unworkable. For example, an automotive assembly plant in Michigan might compete with automotive plants in the Midwest, Canada and Mexico and the automobiles produced at the plant could be shipped worldwide. HB 5578 provides no ascertainable standards on how one determines “the market in which the property subject to assessment competes.”

HB 5578 requires calculation of a “replacement or reproduction cost for property that has the same . . . age as the property subject to assessment.” It is nonsensical to calculate the construction cost to reproduce or replace property that has the same “age” as the property under consideration because, as an example, one cannot construct a 40-year old building. Presumably, what was intended was that cost new would be calculated, with a deduction for the depreciation of the subject property due to age. However, that is not what the plain language of HB 5578 requires.

HB 5578’s Exclusion of Comparable Properties
HB 5578 requires that a comparable property be excluded if its “use” is different than the highest and best use of the property subject to assessment. It is unclear what the term “use” means as applied in this subsection and whether it means “actual use when sold,” “subsequent use after sale,” or “highest and best use when sold.”

The proposed legislation also allows a comparable property to be considered “if the sale or rental of the property occurred under economic conditions that were not substantially different from the highest and best use of the property subject to assessment unless there is substantial evidence that the economic conditions are common at the location of the property subject to assessment.” This provision is absurd. It is impossible to compare “economic conditions” with “highest and best use” and, even if it were possible, it would not make any sense to do so.

For the sale of a comparable property that was vacant at the time of sale, HB 5578 requires consideration of whether “the cause of the vacancy is typical for marketing properties of the same class.” How is a “cause of vacancy” ever “typical for marketing”? HB 5578 further requires consideration of whether “the vacancy does not reflect a use different from the highest and best use of the property. . . .” Conspicuously missing from HB 5578 are any instructions as to the determination of how a vacancy reflects a use.

HB 5578 requires exclusion of a comparable sale property if the comparable property was subject to a deed restriction or covenant, “if that restriction or covenant does not assist in the economic development of the property, does not provide a continuing benefit of the property, or materially increases the likelihood of vacancy. . . .” What is missing from this analysis is any consideration as to whether such a deed or covenant would impact the price at which the property sold. For example, a reciprocal easement on the comparable property that did not “assist in the economic development of the property” but did not impact its sale price likely would be enough to exclude the comparable sale. Such reciprocal easements are commonplace and generally do not affect the price at which property sells.

Conclusion
Few would challenge the fundamental principles that property tax assessments should be uniform and should reflect the value of the fee simple interests of the properties – not the values of the business operations conducted thereon. Yet, the “dark box” bogeyman threatens these cornerstone valuation principles. In both Indiana and Michigan, new legislation gives taxpayers good reason to fear that in future years they may be faced with inflated property tax bills based on non-uniform and inequitable assessments.

 

Brent AuberryBrent A. Auberry is a partner in the Indianapolis office of the law firm Faegre Baker Daniels LLP, the Indiana member of American Property Tax Counsel (APTC), the natonal affiliation of property tax attorneys. Mr. Auberry can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

 

Mandell StewartStewart Mandell is a Partner of the Tax Appeals Practice Group Leader, in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan 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..

 

Daniel L. StanleyDaniel Stanley is a Partner in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan 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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Apr
26

Add Value Through Correct Valuation

Even in a booming market, managing expenses is the best way to ensure the long-term profitability of investment properties. For most student housing, the largest expense after debt service is property tax.

Assessors in college towns are happy to shift the tax burden onto out-of-town students and investors in student housing communities. And due to the perplexing assessment systems in most jurisdictions, owners and developers of student housing communities often treat tax assessments as a given, making appeals the exception rather than the rule. Yet any reduction in the tax burden can substantially increase profitability, so prudent owners monitor tax assessments closely.

Most ad valorem tax disputes hinge on property value. Developers are adept at valuing assets for investment, but there are substantial differences between taxable value and how much a property is worth as an investment. Knowing these differences can protect owners from overzealous assessors.

Identify the right income

Because student housing communities are income-producing properties, developed and purchased for the high-quality income streams they generate, most assessors argue that capitalized income is the best indication of their real estate value. Accordingly, assessors often ask for the property’s historic income and expense information. Taxpayers should be hesitant to provide the property’s operating statements without considering appropriate caveats, however.

In most states, property tax assessments reflect the property’s market value. Consequently, the assessor should value the asset using market levels of rent, vacancy, and expenses – not the property’s actual financial results. Just because the subject student housing operator maximizes revenues, for example, doesn’t mean that all of its competitors do.

Consider vacancy: Because of the school calendar, many student housing communities generate the majority of their annual income in a nine-month window and sit nearly vacant over the summer months. That equates to a market-wide effective vacancy of 25 percent. The fact that one complex appeals to summer students does not mean that competing properties should be valued as fully occupied year-round.

Further, unlike most standard apartments, the rent a student housing community can generate is attributable to substantial non-realty components. Most units are furnished, and rent often includes utilities, premium cable television, high-speed internet and other amenities. As a result, the income stream is not exclusively attributable to the real estate, but to personal property, intangibles, and business value as well. Likewise, some developments have favorable contracts with the university whose students will be housed by the community. Such non-realty components are not taxable, and must be removed. Failing to cleanse the income stream solely to its realty component can result in an overstated, overtaxed property value.

Scrutinize comparable sales

In certain markets, evaluating the selling prices for other student housing communities may be a valid method of determining a property’s taxable market value, but assessors often misinterpret that sales data. Just as a property’s income stream reflects more than the value of the real estate, a sales price – usually based on the same income stream – may reflect more than the value of the realty alone.

The most relevant sales for comparison are those where the real estate transacts without any personal property, intangibles, or business value. Since such sales are rare, an assessor using the sales of nearby student housing communities must take care to remove the value of everything but the realty. This task, often overlooked by assessors, requires identifying and measuring hard-to-value assets with certainty.

Moreover, comparable sales have to be adjusted to account for differences between the sold property and the property being assessed. Three communities might all have the same number of beds, but one might have mostly one- and two-bedroom layouts, while another has more community amenities that appeal to a different mix of students. They may serve different schools with different demographics. If the differences between the properties affect their respective rents, then the sales prices should be adjusted accordingly so they best match the configuration of the subject property.

In the absence of sales of purpose-built student housing, some assessors might be tempted to use sales of other types of multifamily housing. Despite superficial similarities, the properties compete in different markets, which appear as structural differences between the properties. An assessor failing to account for such differences may be making a fundamental error.

Cashing in on unusual cases

As the student housing market grows and matures, a particular community may face other circumstances that require a closer look during tax season. For example, public-private partnerships (P3s) are becoming more common in the student housing marketplace. Whether a taxpayer enters a P3 for monetization, development, or operational purposes, the agreement’s characterization can have substantial property tax consequences. Parties to P3s should keep taxability in mind as they draft contracts.

Similarly, in some states dormitories are exempt from property tax because they are deemed educational property. This exemption has historically extended to dormitories owned and operated by colleges and universities. But some properties owned or managed by third parties may still qualify for exemptions because, for example, the school can be deemed the beneficial owner of the property. Of course, the inverse can also be true, so operators should be cautious when drafting contracts so as not to convert an exempt property into a taxable one.

As the student housing market continues to surge, assessors are eager to expand the local tax base by capturing a piece of that growth. But by focusing on the key distinctions of the student housing market, diligent owners can improve the profitability of existing properties and free capital for new investment.

 

 Ben Blair jpgBenjamin Blair is an attorney in the Indianapolis office of the international law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa 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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Apr
17

Solid Base: Proper Lease Structures Can Reduce Property Taxes

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

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

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

Be Prepared

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

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

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

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

Be Precise

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

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

Flexibility is Key

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

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

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

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

cryder scott jpg

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

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Mar
20

Pennsylvania Supreme Court Takes Up Issue of Reverse Property Tax Appeals Across State

The Philadelphia School District is looking to increase the number of reverse property tax appeals, which could result in more tax dollars for schools such as South Philadelphia High School

Pennsylvania property owners and tenants, who pay some of the highest property taxes in the nation, are no doubt aware of the annual deadline to file a property tax appeal. After all, one look at a new tax bill is often enough to make even the most seasoned tax manager scramble to contact their local tax counsel.

However, very few taxpayers are aware that the assessment they may have accepted as favorable could easily trigger a reverse appeal filed by the local school district.

Assessment appeals filed by the taxing entities, often referred to as reverse appeals, are increasingly common as cash-strapped school districts seek to fill their coffers. Just as a tax manager might view an inflated assessment as a reason to appeal, more and more school districts see potentially under-assessed properties as a much-needed source of additional revenue.

To the bane of many taxpayers, this tactic has now reached the city of Philadelphia. Despite undergoing a citywide property revaluation for the 2014 tax year, with another currently slated for 2018, the Philadelphia School District recently decided to begin filing reverse appeals against properties it feels are under-assessed.

On Sept. 15, 2016, for the first time, the school district authorized the superintendent to contract with an outside law firm for the sole purpose of filing reverse appeals on the district’s behalf. It also authorized the superintendent to contract with Keystone Realty Advisors LLC, a real estate valuation and advisory group that will serve as the primary identifier of under-assessed properties in the city.

Changes a long time in the making

To many in the world of tax appeals, the emergence of reverse appeals in Philadelphia was unsurprising and inevitable. Keystone had previously peddled its services in a number of other Pennsylvania counties, including Lackawanna and Luzerne. Additionally, last year the Philadelphia School District hired Uri Monson to fill the vacant chief financial officer position. Monson previously served as chief financial officer for Montgomery County, another Pennsylvania county that saw a number of school districts utilize Keystone’s services to identify potential reverse appeals.

In Philadelphia, Monson says the reverse appeal initiative will focus on properties that are undervalued by at least $1 million. City Councilman Allan Domb has indicated that there may be up to $75 million in untapped revenue from commercial properties alone. The school district, which receives 55 percent of the city’s total property tax revenue, stands to gain up to $41 million.

According to Monson, reverse appeals are a tool to ensure that the school district’s funding is spread equitably across all taxpayers throughout the city, and are not intended to target particular neighborhoods or classes of property. Commercial taxpayers are not so sure.

Currently pending at the Pennsylvania Supreme Court is the case of Valley Forge Towers Apartments N, LP vs. Upper Merion Area School District and Keystone Realty Advisors, LLC. At issue before the court is whether the Upper Merion Area School District and Keystone Realty Advisors violated the uniformity clause of the Pennsylvania Constitution by selectively filing reverse appeals on commercial properties, while ignoring significantly under-assessed single-family properties.

The court will have to decide whether a school district’s statutory right to file an appeal, and an economic reason for doing so, insulate the district from review when it decides to appeal an assessment.

The long-term results

The Supreme Court’s decision will likely have far-reaching effects. Should the court decide that the school district and Keystone’s method for selecting reverse appeals does indeed violate the uniformity clause, that finding will likely preclude taxing districts throughout the state, including Philadelphia, from selectively filing reverse appeals.

On the other hand, if the court rules in favor of the school district, it will legitimize the current reverse appeal process that is slowly permeating the state. The latter result may even inspire additional taxing districts to explore reverse appeals as a source of revenue generation.

The court has already received over a dozen friend-of-the-court briefs from various groups with an interest in the outcome, seeking to weigh in on the issue.  Oral arguments were heard on March 8, 2017, though it will be months before the court issues a decision.

Whatever the outcome, taxpayers will want to pay close attention to the Supreme Court’s decision, especially those considering purchasing property in Philadelphia or any other school district that actively pursues reverse appeals.

Under the current system, one of the easiest ways for the districts to pick up on potential appeals is to compare the sale price against the property’s current assessment. Unfortunately, this often means unexpected litigation expenses for new property owners and the potential for higher-than-anticipated tax bills.

Gregory Schaffer photo

Gregory Schaffer is an associate at the Montclair, N.J., las firm Garippa Lotz & Giannuario, a New Jersey and Eastern Pennsulvania member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.  He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Feb
01

Putting A Stop To The 'Hidden Property Tax'

When property values rise, tax rates should fall.

Owners should be delighted to see the value of their property increase, but in our current tax environment, higher property values have become synonymous with higher property taxes.

School districts, municipalities, counties and other taxing units have the power to limit property tax bills by lowering their respective tax rates as property values rise. Instead of doing this, however, many taxing entities opt for a tax revenue windfall.

Remarkably, as they collect this additional revenue, these same taxing units claim that they have not raised taxes because they have not increased their tax rate. This distinction has afforded taxing units a convenient escape from the ire of taxpayers. But is it fair?

The Texas property tax system has two components: appraisal districts and taxing authorities. First, appraisal districts assess the market value of taxable property within their boundaries. They then participate in protest hearings initiated by property owners about those values and subsequently certify appraisal rolls for taxing entities.

Second, the governmental bodies that levy and collect taxes prepare budgets and, with their certified appraisal rolls in hand, adopt tax rates sufficient to meet those budgets. Then these municipalities, school districts and other institutions send out tax bills and collect tax revenue.

Both appraisal districts and taxing authorities have the power to affect property owners’ ad valorem tax liability. Nevertheless, many media outlets and news publications have blamed appraisal districts exclusively when tax bills have increased.

For instance, on April 11, 2016, the Austin American-Statesman reported: “Home values rise 9 percent in Travis County!” The San Antonio Express-News reported on May 4, 2016, “2016 Bexar County property value is up $13 billion over year before, real estate values up 7.5 percent.” Similarly, on May 25, 2016, the Dallas Morning News warned about “A taxing problem,” specifically discussing how “Dallas property taxes squeeze middle class” because homeowners in that demographic saw an average increase in the value of their homes of over 11 percent.

These news articles focus on the distress that rising appraised values have inflicted upon taxpayers as property tax bills have increased. Is it fair, though, to malign appraisal districts when they are simply fulfilling their charge to assess property values, especially when they do not participate in the tax rate setting process?

State Sen. Paul Bettencourt (R-Houston), who served as the Harris County tax assessor-collector from 1998 through 2008, formed the Senate Select Committee on Property Tax to look into the issue. The Committee has held public hearings all around the state to listen to taxpayers’ concerns arid frustrations about the system.

It has become apparent that the root of the rising property tax burden lies with tax rates set by taxing units, not in appraised values assessed by appraisal districts. Indeed, at a hearing in Arlington earlier this year, there were hundreds of property owners in the audience, but not one complaint about the Dallas Central Appraisal District or the work of its Chief Appraiser, Ken Nolan.

The issue has caught the attention of a number of politically astute organizations, including the Texas Association of Realtors, which has taken a strong interest in Texas’ property tax policy. Its Director of Legislative Affairs, Daniel Gonzalez, has made it his mission to educate the public about what he describes as the “hidden property tax.” This includes spending resources to maintain the informational website, hiddenpropertytax.com, which provides videos, articles, and other details about the problem.

Likewise, certain taxing entities have spoken out against this “hidden property tax.” The mayor of Fort Worth, Betsy Price, in an opinion piece that appeared in the May 19, 2016 edition of the Fort Worth Star Telegram, wrote: “What to do about high property tax assessments? Cut the tax rate.” The Dallas Morning News echoed this sentiment on May 25, 2016, when it explained, “The only way officials can reduce the burden on taxpayers is by lowering their tax rates.”

And why shouldn’t taxing units do this? Our truth-in-taxation laws are supposed to prevent excessive taxation by limiting tax rate increases that lead to higher tax revenues. The same principle should apply when tax rates remain steady, but through the increase in property values, tax revenues soar. That is an unintended consequence of the prosperity of a community that governments should not be able to exploit.

Texas has one of the nations best property tax systems. To make it work, however, appraisal districts and taxing entities alike must do their part in maintaining the system’s integrity and fairness. Local taxing units should not be allowed to hide behind increased appraised values to raise their budgets, nor should the Texas legislature be able to take advantage of higher appraised values by sending less funding per student to school districts.

Instead of vilifying appraisal districts and complaining about a “broken” property tax system, property owners should put pressure on school districts, cities, counties and other taxing entities to exhibit greater accountability and transparency over tax rates.

daniel smith active at popp hutcheson

Daniel R. Smith serves as general counsel  in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He represents commercial property owners in property tax appeals across the state, and can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Dec
16

Replacement Reserves Can Significantly Reduce Property Tax Bills

Funds set aside to maintain, repair and upgrade capital assets are the lifeblood of many commercial properties today. Known as “reserves for replacement,” the treatment of these major operating expenses in the calculation of a property’s value can significantly influence its tax burden. Mishandling that calculation can cost a taxpayer dearly.

Replacement funds are essential resources that enable hotels and resorts to renovate every few years, a critical task if they are to remain competitive. Likewise, department stores and most in-line retailers in shopping centers must rejuvenate their properties in order to keep customers coming. Even fast food outlets must update their spaces, as well as their menus, on a regular basis to maintain sales.

The sums that hospitality, retail and food outlets spend to renovate or refresh their properties on a regular basis are sizable, sometimes as much as 5 percent of total revenues. Reserves are a significant expense these properties must bear, and have a major impact on a property’s bottom line.

Property tax assessments for commercial properties usually reflect income that the properties produce. The greater a property’s net revenue, the higher the property’s assessed value and tax burden will be. Clearly, it is in the taxpayer’s interest to make sure tax assessors do not inflate that net revenue by improperly accounting for expenses in their value calculations.

Above the Line or Below?

In many industries, replacement reserves are an above-the-line expense deduction, which means they are deducted along with other operating expenses to determine net operating income. If the reserve is large, its deduction can greatly reduce a property’s net income.

Why do accountants and appraisers handle reserves this way? Because the above-the-line deduction of reserves permits properties to be compared on an apples-to-apples basis.

For example, the replacement reserves deduction for one hotel may vary from the deduction for another hotel for a variety of reasons, including intensity of use, age of the facility and so forth, based on the owner /operator’s knowledge of what is needed to keep that hotel competitive.

Removing reserves from the picture enables an appraiser or assessor to compare the net income performance of comparable competing properties on a uniform basis. Such comparisons are also important to investors.

Reserves and Property Taxes

As described above, the deduction of replacement reserves as an expense affects a property’s net income. If the assessor fails to deduct the reserves, or deducts them after net income in a below-the-line calculation, the net income will be higher. Conversely, if the appraiser deducts reserves as an operating expense, net income will be lower.

Net income often underpins property tax values and tax assessments. If the assessor deducts reserves and net income is lower, then the property’s taxes will be lower. If not, the taxes will be higher.

In some states, including California, tax authorities mimic market participants in their treatment of reserves. That means that for some properties, assessors deduct reserves so that properties can be directly compared for appraisal and valuation purposes. The consistent handling of reserves also permits taxing authorities to develop capitalization rates from comparable sales transactions.

Reporting Inconsistencies can Increase Taxes

While participants in a particular real estate sector — say, hospitality or retail — generally handle reserves in the same way, it is difficult to learn about the amount of replacement reserves deducted for a specific property due to the confidentiality of financial statements. If financial statements are available, the property’s operator may ignore industry standards and report reserves below the line, or may not report reserves at all.

The amount of reserves reported, usually as a percentage, may also vary from property to property even within the same property class. Finally, a property operator may simply use an arbitrary figure for reserves, which does not represent the actual cost of the replacement reserve deduction incurred.

Disparities in reporting reserves can significantly skew the net income, which is the basis for a property’s assessed value and property tax bill. Taxing authorities exacerbate the problem when they handle replacement reserves inconsistently, either because of inconsistent reporting or because the assessor attempts to correct financial statements that omit replacement reserves or appear to inaccurately report replacement reserves. If the assessor uses incorrect data, or incorrectly adjusts the data, the property values will be incorrect and the taxes based on those values will be erroneous.

Getting Reserves and Taxes Right

Taxpayers can insure their local assessor properly handles reserves in assessing and taxing their properties by taking these simple steps.

1.  If the taxpayer provides financial statements to the tax authorities, make sure to report replacement reserves consistently with industry practice. If most industry participants report on an above-the-line basis, follow that practice.

2.  If the taxpayer is spending replacement reserves, report the full amount of those reserves. Failure to report or under-reporting will likely increase the property’s taxes.

3.  Ask to see the financial statements from other properties that the taxing authority is using to value the property. If the assessor won’t disclose those statements, at least ask to see the portion showing the amount of reserves and the how they are being handled.

4. If investigation shows that reserves are being improperly handled and a property is over-valued, meet with the tax authority’s appraiser to discuss the situation and, if necessary, use the appeals process to correct the assessment. 

Cris ONeall

Cris K. O'Neall is a shareholder at the law firm Greenberg Traurig, LLP and focuses his practice on ad valorem property tax assessment counseling and litigation.  The firm is the California 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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Dec
15

Market-Value Tax Assessments Under Attack

Governments increasingly seek tax increases through value-in-use property taxation.f the compelling evidence is on your side, the record shows you have a fighting chance.

An unprecedented national debate is raging as vocal proponents of additional government revenue seek significant property tax changes that will be costly to taxpayers.

A recent Michigan Court of Appeals decision in Menard Inc. v. Escanaba (the “Menard decision”), which involved a Menards hardware store in the Michigan Upper Peninsula City of Escanaba, confirms that proponents of greater taxation are masking their true goals with claims that they merely seek equitable taxation. Consequently, it is important for property owners to understand the issues involved.

Typically, property taxes reflect market value rather than a property’s value-in-use, which is the value to the owner. The market value standard bases taxes on the amount the property probably would fetch, after reasonable market exposure, in a sale between two knowledgeable, unrelated parties.

With the exception of the right to appeal under due process, no property tax component is more essential to taxpayers than basing taxation on market value, and not on value-in-use. The market value standard provides a framework for equitable and uniform property taxation.

Market value bases taxes on what is achievable in a market sale, determined through objective information such as comparable sales, rental income, operating expenses, capitalization rates and other market information.

Important distinctions

With market value taxation, a property’s value is unaffected by who owns the property, or whether the owner is able to use the property to operate a successful business. For example, a retailer, manufacturer, or cloud data storage provider may use intangible and tangible property, including real estate, in a way that achieves extraordinary income from business operations. This does not change the market value of the real property used.

In contrast, value-in-use taxation is inequitable and non-uniform. Consider two identical, neighboring residential properties that have the same market value. Their value-in-use would most likely differ, and the differences could be dramatic. The disparity could be because one house has more occupants, or because one property is used only part of the year.

Alternatively, one house could have greater value-in-use because a resident generates significant income from work done while in the home, such as in a home office or studio. Also, when one of these identical properties sells, the property’s value-in-use could substantially increase or decrease.

Those who seek value-in-use taxation might argue that such taxation is equitable because owners who obtain more value from using their properties should pay higher property taxes. But consider some of this position’s enormous failings:

  • Most people would readily agree that the most equitable system is one in which all properties are uniformly valued based on their usual selling price, rather than their differing values in use.
  • Value-in-use taxation is highly subjective and inherently inequitable. Imagine the problems and disputes if properties were valued based on the value each owner experienced.
  • Value-in-use assessment would result in duplicative taxation. If a property is used in conjunction with a business, whether the property is a residence or otherwise, value-in-use property taxation will reflect the business’s income and success. Yet, there will be duplicative taxation where other taxes are imposed on the business, such as income taxes, gross receipts taxes and value-added taxes.

Given the enormous problems with value-in-use taxation, taxpayers could understandably think there is little risk that such taxation would be adopted.

Unfortunately, those seeking value-in-use taxation have shrewdly focused on the taxation of large big-box retail properties, which they claim have been unfairly valued based on sales of vacant properties that allegedly had value-depressing deed restrictions.

The proponents of greater taxation have even tried to divide taxpayers by suggesting that some taxpayers will pay higher taxes because big-box taxpayers are not paying their fair share.

Keys to the truth

Developers build big-box retail properties to the owner’s specific needs, typically with a layout matching the owner’s other stores. Buyers of such properties invariably pay far less than the cost to construct such properties. They do so because they will spend large sums for renovations the new owner desires, in particular to fit a business image.

Also, there is reduced demand for these properties. It’s what appraisers call external obsolescence – especially with growing industry disruption from Internet sales. There are numerous sales of big-box properties without deed restrictions that confirm the selling prices for these properties are low compared with their construction costs.

Notwithstanding these irrefutable truths, the Menard decision held that an assessor could value the property under a cost approach, as if the property had no functional obsolescence. According to the Michigan Court of Appeals decision, a buyer would consider a property suitable for its own needs, merely because the property satisfied the needs of its original owner.

Such reasoning obviously values the property based on its value to the original owner – i.e., value-in-use, not its market value. These principles are the same whether dealing with a non-residential property or a home that has been custom built to an owner’s unusual tastes.

Significantly, the Menard decision specified that value-in-use taxation also could apply to a large industrial property. And a prior Michigan Court of Appeals decision endorsed value-in-use for the headquarters of a financial institution. Once the value–in-use genie is out of the bottle, it can cause above-market valuations and increased taxes for virtually any type of property.

Notably, the pro-government briefs that oppose Menards appeal to the Michigan Supreme Court deny that the decision endorses value-in-use taxation. These denials, like those in the press made by advocates of greater taxation, disregard that the Menard decision itself uses the very words “value-in-use" in endorsing such taxation. It remains to be seen if the Michigan Supreme Court will review the Menard decision, and it could be a year or more before the case’s ultimate outcome is known.

High stakes game

Some in the business community are responding to today’s property tax debate as they would to any intense effort to broadly raise property taxes. Such groups understand what is at stake and are defending market value-based property taxation for all properties.

Yet those who seek higher taxes appear to be strongly united. Whether they succeed in imposing value-in-use taxation may well depend on whether the business community itself will unite to oppose what eventually could become an enormous tax increase.

To paraphrase Abraham Lincoln, a business community divided against itself will inevitably succumb to the united forces that seek greater taxation.

Mandell Stewart jpg

Stewart Mandell is a Partner of the Tax Appeals Practice Group Leader, in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan 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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Dec
07

Superstorm Sandy's Impact On Property Taxes

Mistaking rehabilitation for new construction, assessors inflate post-superstorm tax assessments.

Four years have passed since Superstorm Sandy slammed the East Coast and crippled the Northeast. The overwhelming majority of media coverage centered on the devastation suffered by residential properties, paying little attention to the tens of thousands of commercial property owners who suffered equally historic destruction.

The rebuilding process has been a feast for local tax assessors, who have increased property assessments throughout these Sandy-stricken areas based on the misguided opinion that rehabilitated commercial properties should be valued as newly constructed buildings, ignoring the financial realities and stigma attached to "Sandy properties."

The post-Sandy rebuilding process has taken years, requiring commercial property owners to overcome insurance claim nightmares, bureaucratic red tape, and the massive exodus of tenants who either lost their businesses or relocated as a result of the storm. Too often, local tax assessors ignored the hardships suffered by these property owners, taking advantage of the reconstruction by increasing assessments well above pre-Sandy values to increase their tax base.

Fortunately, the laws of each state allow landlords or property owners to reduce unfairly increased property tax assessments by filing a commercial tax appeal. These appeals offer the owner or the owner's representative the opportunity to prove that the property is worth less than its current taxable value. Whether that tax-reduction opportunity occurs at an administrative hearing, through negotiations or in the courtroom, taxpayers are best served by seeking the expertise of an attorney experienced in navigating the appeals process and the valuation of commercial properties.

Proper Valuation vs. Unfair Increases

Traditional methods to valuing commercial real estate for property taxation include the sales-comparison, cost, and income capitalization approaches.  Sales comparison typically relies upon arms length sales data. Unfortunately, there is very little arms-length transaction data in Sandy-ravaged areas because the market has been flooded with sales of distressed properties.

The cost approach should only be applied when valuing new construction or specialty properties.

When tax assessors value commercial buildings as in-come-producing properties, they capitalize the subject's net income stream, or if owner-occupied, the income it would generate if leased. Appraisal professionals and the courts agree that this income-capitalization approach is the preferred method of valuation at a commercial tax appeal.

Nevertheless, local tax assessors have been leaning on the cost approach when valuing post-Sandy re-habilitated retail properties. These assessors mistakenly perceive a property owner's rehabilitation or reconstruction work as equivalent to a capital improvement or new construction, at the same time ignoring the economic realities that these property owners faced as a result of the storm. More specifically, the cost approach ignores increased expenses, extended periods of vacancy and the difficulty that landlords continue to face in luring tenants back to properties destroyed by the storm. This unfortunate valuation practice has inflated tax assessments and created unfair tax burdens.

Hidden Costs Linger

Sandy's impact runs deeper than brick and mortar reconstruction. Cleanup, rehabilitation and lingering stigma have forced landlords to contend with increased expenses and lengthy vacancies. The stigma that follows a "Sandy property" is similar to that attached to cars sold in New Orleans after Hurricane Katrina, engendering the burdensome label of "Katrina cars."

Like suspicious car buyers in Katrina's wake, prospective tenants either ran for the hills or demanded low rents with short-term leases after learning that a property was ravaged by Sandy. The fear of the unknown resulted in tenants searching for what they perceived as less risky locations further inland.

In addition to disproportionately high vacancies, Sandy-stricken property owners have had to contend with significantly increased expenses. Insurance is one example. Not only have premiums skyrocketed due to the perceived risk of owning property near Sandy's point of impact, but the Federal Emergency Management Agency has issued new flood zone maps that expand many flood zones inland. Flood zone boundaries have compelled landlords to purchase flood insurance in areas that are relatively far from the shore, regardless of whether their property incurred damage from the storm.

Property owners typically bore the costs to rehabilitate flooded and destroyed properties, because many insurance companies exclude wind or hurricane damage from coverage. Other properties sustained damages in excess of policy limits. Unfortunately, many owners lacked the necessary funds to rehabilitate, leaving entire shopping centers abandoned.

Property owners who were lucky enough to have full coverage still had to deal with empty buildings and high carrying costs for many months during ongoing construction.

Taxpayers Fight Back

The key to a successful property tax appeal is to arrive armed with data supporting the argument that the subject property is worth less than its assessed, taxable value. For commercial property, the owner or their representative should analyze the subject's income and expense history, together with market data of similar properties in the area. For a Sandy property, this analysis should concentrate on the actual economic harm suffered as a result of Sandy and its aftermath.

In order to do this, prior to filing a property tax challenge, the taxpayer's representative should review copies of the leases, rent rolls and income and expense data of the subject from the last five years. Assuming the asset suffered major vacancies, the property owner's representative must be prepared to discuss and produce documentation or an affidavit attesting to the hardships faced in trying to rent the property and overcome the stigma associated with marketing Sandy-stricken space. In addition, the owner must be prepared to produce and discuss all insurance claims, including awards and denials, and provide an accounting of all out-of-pocket costs associated with the property's rehabilitation.

A carefully prepared and documented presentation of the facts offers the owner a real possibility to avoid unfairly high property tax assessments on these Sandy-impaired properties.

Hild and PenighettiRyan C. Hild and Jason M. Penighetti are attorneys at the Mineola, N.Y., law firm of Koeppel Martone & Leistman LLP, the New York State member of Amercian Property Tax Counsel, the national affiliation of property tax attorneys.  Contact Ryan at This email address is being protected from spambots. You need JavaScript enabled to view it. or Jason at This email address is being protected from spambots. You need JavaScript enabled to view it.

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