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Property Tax Resources

Jul
09

Expect Increased Property Taxes

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

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

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

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

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

RATES, DATES AND VALUES

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

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

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

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

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

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

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

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

OBSOLESCENCE ISSUES

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

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

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

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

DON'T DELAY TAX PLANNING

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

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

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

Morris Ellison is a partner in the Charleston, S.C., office of the law firm Womble Bond Dickinson (US) LLP. The firm is the South Carolina member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Jun
09

Navigating D.C.’s Tax Rate Maze

An evolving and imperfect system has increased property taxes for many commercial real estate owners.

If you own or manage real property in the District of Columbia and are wondering why your real estate tax bill has gone up in recent years, you are not alone. One common culprit is rising assessed value, but that may not be the main or only source of an increase.

A less obvious contributor may be a new, different, or incorrect tax rate. Since tax rates vary greatly depending on a property's use, staying diligent when it comes to your real estate's tax class and billed rate is critical.

The District of Columbia applies differing tax rates to residential, commercial, mixed-use, vacant and blighted properties. Why is this important? Because the classification can make a considerable difference in annual tax liability – even for two properties with identical assessment values.

For example, a multifamily complex assessed at $20 million incurs a tax liability of $170,000 per year while the same property, if designated as blighted, incurs an annual tax liability almost twelve times greater at $2 million. Therefore, the assessed value is just one piece of the puzzle.

Keeping a sharp eye on a property's tax bill for the accuracy of any tax rate changes is paramount. This requires knowledge of current rates, the taxpayers' legal obligations, and how to remedy or appeal any issues that arise.

New Rates for Commercial Property

Property owners in the District should be aware of a recent change to tax rates on commercial real estate. The Fiscal 2019 Budget Support Emergency Act increased rates for commercial properties starting with Tax Year 2019 bills.

Prior to the enactment of this legislation, the District taxed commercial properties with a blended rate of 1.65% for the first $3 million in assessed value and 1.85% for every dollar above $3 million. The new measure replaces the blended rate with a tiered system, taxing a commercial property at the rate corresponding to the level in which its assessed value falls. Those levels are:

Tier One, for properties assessed at $0 to $5 million, taxed entirely at 1.65%;

Tier Two, for properties assessed at $5 million to $10 million, taxed entirely at 1.77%; and

Tier Three, for properties assessed above $10 million, taxed entirely at 1.89%.

The residential tax rate for multifamily properties remained flat at 0.85%.

Mixed Use

The District of Columbia Code requires that real property be classified and taxed based upon use. Therefore, if a property has multiple uses, taxing entities must apply tax rates proportionally to the square footage of each use. However, it is ownership's legal obligation to annually report the property's uses by filing a Declaration of Mixed-Use form. Owners of properties with both residential and commercial portions should be hypersensitive to this issue.

The District typically mails the Declaration of Mixed-Use form to property owners in May, and the response is due 30 days thereafter. If the District fails to send a form to an owner, it is the owner's responsibility to request one. Remember, the owner must recertify the mixed-use asset each year. Failure to declare a property as mixed-use may result in the entire property including the residential portion being taxed at the commercial tax rate (up to 1.89%).

Vacant & Blighted Designation

If you have ever opened a property tax bill and faced a staggering 5% or 10% tax rate, congratulations, your property was taxed at one of the District's highest real estate tax rates.

Each year the Department of Consumer and Regulatory Affairs (DCRA) and the Office of Tax and Revenue are charged with identifying and taxing vacant and blighted properties in the District. The D.C. Code defines vacant and blighted properties for this purpose, and there is a detailed process governing why and when DCRA may classify a property as vacant. Nonetheless, in each tax cycle DCRA wrongfully designates properties as vacant or blighted, so it is paramount that the taxpayer understands their appeal rights.

To successfully appeal a vacant property designation, an owner must comply with one of the specifically enumerated and highly technical exemptions. One such exemption applies if the property is actively undergoing renovation under a valid building permit. However, the taxpayer should consult with an attorney, as there may be other requirements to qualify for an exemption. An owner wishing to appeal this designation must file a Vacant Building Response form and provide all applicable supporting documentation to DCRA.

Moreover, an owner may appeal a property's blighted designation by demonstrating that the property is occupied or that it is not blighted. Since an appeal of a blighted designation requires a more detailed review of the condition of the property itself, photographic evidence must be used to supplement any documentation provided.

Fixing Erroneous Rates

When dealing with local government and statutory deadlines, time is not on the taxpayer's side. It is important that as soon as an error is identified, the property owner understands the next steps. In some situations, the D.C. code or official government correspondence will lay out the process precisely for the property owner, identifying the who, what, where, when, why and how's of appealing a property's tax designation. However, sometimes a taxpayer will receive a bill without explanation.

In both scenarios, it is best to consult with a local tax attorney.  These professionals have experience dealing with these issues, as well as with the corresponding governmental entities.  A knowledgeable counselor can be an invaluable resource to guide you through any tax issue.

Sydney Bardouil is an associate at the law firm of Wilkes Artis, the District of Columbia member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Apr
17

Higher Property Tax Values in Ohio

The Buckeye State's questionable methods deliver alarmingly high values.

A recent decision from an Ohio appeals court highlights a developing and troubling pattern in the state's property tax valuation appeals. In a number of cases, an appraiser's misuse of the highest and best use concept has led to extreme overvaluations. Given its potential to grossly inflate tax liabilities, property owners and well-known tenants need to be aware of this alarming trend and how to best respond.

In the recently decided case, a property used as a McDonald's restaurant in Northeast Ohio received widely varied appraisals. The county assessor, in the ordinary course of setting values, assessed the value at $1.3 million. Then a Member of the Appraisal Institute (MAI) appraiser hired by the property owner calculated a value of $715,000. Another MAI appraiser, this one hired by the county assessor, set the value at $1.9 million. The average of the two MAI appraisals equals $1.3 million, closely mirroring the county's initial value.

Despite the property owner having met its burden of proof at the first hearing level, the county board of revision rejected the property owner's evidence without analysis or explanation. The owner then appealed to the Ohio Board of Tax Appeals (BTA).

In its decision on the appeal, the BTA focused on each appraiser's high-est and best use analysis. The county's appraiser determined the highest and best use is the existing improvements occupied by a national fast food restaurant as they contribute beyond the value of the site "as if vacant." The property owner's appraiser determined the highest and best use for the property in its current state was as a restaurant.

With the county appraiser's narrowly defined highest and best use, the county's sale and rent examples of comparable properties focused heavily on nationally branded fast food restaurants (i.e. Burger King, Arby's, KFC and Taco Bell). The BTA determined that the county's appraisal evidence was more credible because it considered the county's comparables more closely matched the subject property.

By analyzing primarily national brands, the county's appraiser concluded a $1.9 million value. Finding the use of the national fast food comparable data convincing, the BTA increased the assessment from the county's initial $1.3 million to the county appraiser's $1.9 million conclusion.

On appeal from the BTA, the Ninth District Court of Appeals deferred to the BTA's finding that the county's appraiser was more credible, noting "the determination of [the credibility of evidence and witnesses]…is primarily within the province of the taxing authorities."

Questionable comparables

Standard appraisal practices demand that an appraiser's conclusion to such a narrow highest and best use must be supported with well-researched data and careful analysis. Comparable data using leased-fee or lease-encumbered sales provides no credible evidence of the use for which similar real property is being acquired. Similarly, build-to-suit leases used as comparable rentals provide no evidence of the use for which a property available for lease on a competitive and open market will be used. However, this is exactly the type of data and research the county's appraiser relied upon.

A complete and accurate analysis of highest and best use requires "[a] n understanding of market behavior developed through market analysis," according to the Appraisal Institute's industry standard, The Appraisal of Real Estate, 14th Edition. The Appraisal Institute defines highest and best use as "the reasonably probable use of property that results in the highest value."

By contrast, the Appraisal Institute states the "most profitable use" relates to investment value, which differs from market value. The Appraisal of Real Estate defines investment value as "the value of a certain property to a particular investor given the investor's investment criteria."

In the McDonald's case, however, the county appraiser's highest and best use analysis lacks any analysis of what it would cost a national fast food chain to build a new restaurant, nor does it acknowledge that the costs of remodeling the existing improvements need to be considered.

If real estate is to be valued fairly and uniformly as Ohio law requires, then boards of revision, the BTA and appellate courts must take seriously the open market value concept clarified for Ohio in a pivotal 1964 case, State ex rel. Park Invest. Co. v. Bd. of Tax Appeals. In that case, the court held that "the value or true value in money of any property is the amount for which that property would sell on the open market by a willing seller to a willing buyer. In essence, the value of property is the amount of money for which it may be exchanged, i.e., the sales price."

Taxpayers beware

This McDonald's case is not the only instance where an overly narrow and unsupported highest and best use appraisal analysis resulted in an over-valuation. To defend against these narrow highest and best use appraisals, the property owner must employ an effective defense strategy. That strategy includes the critical step of a thorough cross examination of the opposing appraiser's report and analysis.

In addition, the property owner should anticipate this type of evidence coming from the other side. The property owner's appraiser must make the effort to provide a comprehensive market analysis and a thorough highest and best use analysis to identify the truly most probable user of the real property.

Steve Nowak, Esq. is an associate in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Apr
16

Property Tax Crush Demands Action

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

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

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

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

Widespread devaluations likely

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

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

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

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

Appeal to lawmakers

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

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

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

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

Jerome Wallach is a partner at The Wallach Law Firm in St. Louis, the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Apr
15

Property Tax Planning Delivers Big Savings

Ask the right questions, understand your rights and develop a strategy to avoid costly mistakes.

When it comes to property taxes, what you don't know can hurt you. Whether it is failing to meet a valuation protest deadline, ignorance of available exemptions or perhaps missing an error in the assessment records, an oversight can cost a taxpayer dearly. Understanding common mistakes — and consulting with local property tax professionals — can help owners avoid the pain of unnecessarily high property tax bills.

Think ahead on taxes

Many owners ignore property taxes until a valuation notice or tax bill arrives, but paying attention to tax considerations at other times can greatly benefit a taxpayer. For example, it's good practice to ask the following questions before purchasing real estate, starting a project or receiving a tax bill:

Does the property qualify for exemptions or incentives? Every state offers some form of property tax exemptions to specific taxpayers and property types. Examples include those for residential home-steads, charitable activities by some nonprofits and exemptions for pollution control equipment. Similarly, governments use partial or full property tax abatements in their incentive programs for enticing businesses to expand or relocate to their communities. While many of these programs are industry-specific, it is important to consider all of the taxpayer's potential resources and the costs and benefits of pursuing each.

In most cases, a taxpayer must claim an exemption or obtain an abatement in order to receive its benefits. Failing to timely do so may lead to the forfeiture of an applicable exemption. If the taxpayer becomes aware after the deadline that it may have qualified for an exemption, it is still prudent to speak with a local professional.

Once the exemption is in place, review the assessment each year to ensure it is properly applied. Additionally, taxpayers and their representatives should closely follow legislative action affecting the exemptions that may be available.

How will a sale or redevelopment affect the property's tax value? For instance, will the sale trigger a mandatory reassessment or perhaps remove a statutory value cap? If a change in use removes an exemption, will it trigger rollback taxes or liability equal to the amount of taxes previously excused under the exemption? Will the benefit of an existing exemption be lost for the following tax year?

Taxpayers that fail to ask these questions risk underestimating their tax bill, which can quickly under-mine an initial valuation analysis and actual return.

Learn whether the purchaser or developer must disclose the sales price or loan amount on the deed or other recorded instruments. If so, avoid overstating the sales price by including personal property, intangible assets or other deductible, non-real estate items. Assessors often use deed and mortgage records in determining or supporting assessed value, and it can be an uphill battle trying to argue later why a disclosed sales figure is not the real purchase price.

Don't assume, without further inquiry, that the tax value will stay unchanged following a sale; nor that it will automatically increase or decrease to the purchase price. In determining market value, the assessor may consider (or disregard) the sale in a variety of ways depending on the jurisdiction, transaction timing, arm's-length condition and other factors.

Perhaps the assessor will change the cost approach assumptions to chase a higher purchase price, or disregard a lower sales price suspected of being a distressed transaction. A local, knowledgeable adviser can help the taxpayer set reasonable expectations for future assessments following a sale or redevelopment.

Plan to review, challenge

Before the valuation notice or tax bill arrives, make a plan to review it and challenge any incorrect assessments within the time allowed. An advocate who thoroughly under-stands local assessment methodologies and appeal procedures can be invaluable in helping to craft and execute a response strategy.

The first hurdle in any property tax protest is learning the applicable deadlines. This can be more difficult than it appears, as local laws don't always require a valuation notice. For instance, some states omit sending notices if the value did not increase from the prior year. Additionally, many states reassess on a less-than-annual basis, although there may be different periods within the reassessment cycle in which appeals can be filed.

It is critical to understand the reassessment cycle and protest periods in every jurisdiction in which a taxpayer owns property. Missing a deadline or required tax payment can result in the dismissal of a valuation appeal, regardless of its merits.

The owner, or the company's agent, should understand not only appraisal methodology but also legal requirements governing the assessor. Is there a state-prescribed manual that dictates the application of the cost approach? Does the assessor use a market income approach to value certain property types?

In some jurisdictions, assessors reject the income approach to value if the owner fails to submit income in-formation by a specific date. In others, submitting income information may be mandatory.

With mass appraisal, assessors often make mistakes that will go undetected if not discovered by the taxpayer's team. Has the assessor's cost approach used the correct build-ing or industry classification, effective age of improvements, square footage, type of materials, number of plumbing fixtures, ceiling height, type of HVAC system, etc.?

Even one small error could skew the final value and should be timely brought to the assessor's attention, whether or not in a formal protest setting.

In addition to correcting the error for future assessments, the owner should determine whether it is entitled to a refund for previous taxes paid and, if so, timely file any refund petitions.

With countless jurisdictions and varying assessment statutes, it is unreasonable to expect a property owner to master property tax law. Yet with proper planning and local advisors, taxpayers can avoid pitfalls they may have otherwise overlooked.

Aaron Vansant is a partner at DonovanFingar LLC, the Alabama member of American Property Tax Counsel, the national affiliation of property tax attorneys​.
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Mar
09

The Terrible T’s of Inventory: Timing and Taxes

​States that impose inventory taxes put their constituent businesses at a competitive disadvantage.

Inventory taxes pose an additional cost of doing business in more than a dozen states, and despite efforts to mitigate the competitive disadvantage the practice creates for many taxpayers, policymakers have yet to propose an equitable fix.

Virtually all states employ a property tax at the state or local level. The most common target is real property, which is land and land improvements; and tangible personal property such as fixtures, machinery and equipment.

Nine states also tax business inventory. Those are Texas, Louisiana, Oklahoma, Arkansas,Mississippi, Kentucky, West Virginia, Maryland and Vermont. Another four states – Alaska, Michigan, Georgia and Massachusetts – partially tax inventory. In these 13 states, inventory tax contributes a significant portion of overall property tax collections.

From a policy standpoint, however, inventory tax is probably the least defensible form of property tax: It is the least transparent of business taxes; is "non-neutral," as businesses with larger inventories, such as retailers and manufacturers, pay more; and it adds insult to injury for businesses whose inventory is out of sync with finicky consumer buying habits.

A few fixes

Taxpayers have had few options in attempting to reduce inventory tax liability because an inventory's valuation is seldom easily disputed. So, modeling a classic game of cat and mouse, some enterprising businesses would move their inventory to the jurisdiction with the lowest millage, frantically shuttling property about before the lien date. Taxing jurisdictions eventually caught on, however, and many of these states adopted an averaging system whereby taxpayers must report monthly inventory values that are then averaged for the year. So much for gaming the timing of taxes.

The underlying problem is that imposing an inventory tax puts that state's businesses at a competitive disadvantage. At the same time, local jurisdictions cannot easily afford to give up the revenue generated by inventory taxes.

When West Virginia was contemplating phasing out its inventory tax, one state legislator pointed out that the proposal placed elected representatives in the predicament of telling educator constituents the state could not afford to pay them sufficiently, while turning to another group of business constituents and relieving them of a tax burden which would create a hole in the state's revenues.

Some states including Louisiana and Kentucky have implemented creative workarounds, such as giving income or corporate franchise tax credits to businesses to offset their inventory tax liability. But these imperfect fixes add uncertainty and unnecessary complexity to a state's tax code.

For instance, when Louisiana implemented a straightforward inventory tax credit in the 1990s, businesses paid local inventory tax and were reimbursed for the payments through a tax credit for their Louisiana corporation income/franchise tax liability. The state Department of Revenue fully refunded any excess tax credit.

Between 2005 and 2015, however, the state's liability more than doubled. In 2015, the Legislature imposed a $10,000 cap on the refundable amount of an inventory tax credit and allowed any unused portion of an excess tax credit to be carried forward for a period not to exceed five years. Then in 2016, lawmakers increased the fully refundable cap to $500,000 and adjusted how the excess tax credit could be taken, but left the carry-forward period unchanged. This has created another inventory tax timing problem: Businesses now lose any unclaimed excess tax credit at the end of that carry-forward period, and businesses have no assurances that the tax credit amounts won't be lowered or otherwise made less user-friendly the next time the state faces a fiscal crunch.

Kentucky recently implemented its own inventory tax credit system. Even less taxpayer friendly than Louisiana's approach, it provides only a nonrefundable and nontransferable credit against individual income tax, corporation income tax and limited liability entity tax. The state is phasing in the tax credit in 25% increments each year until it is fully claimable in 2021.

Texas has taken a different tack by offering businesses a limited, $500 exemption for inventory tax. Unadjusted for inflation since its implementation in 1997, however, the exemption for business personal property has lost relative value as the cost of living has increased. The Texas Taxpayers and Research Association recently evaluated Texas' inventory tax and found that the $500 exemption in today's dollars is equivalent to only $367 in 1997 dollars. The association further noted that a property valued at $500 generates, on average, a tax bill of $13, which is less than the likely cost of administering the tax. Not surprisingly and quite rightly, the association recommended increasing the amount of the exemption.

Clearly, these workarounds are not really working for this problem. What's the best solution for Louisiana, Kentucky, Texas and the rest of the inventory tax states? Join the rest of the crowd and simply abolish the inventory tax, as a task force created by the Louisiana Legislature recommended in 2016. No more cat and mouse games, no more paltry exemptions and no more convoluted tax credits. At least in this regard, businesses in all states would be on the same competitive footing.

Angela Adolph is a partner in the law firm of Kean Miller LLP, the Louisiana member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Feb
03

Why Assessor Estimates Create Ambiguity

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

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

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

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

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

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

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

FAIRNESS FOR THE COMMON GOOD

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

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

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

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

SEEK UNIFORMITY, CLARITY

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

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

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

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

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

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

J. Kieran Jennings is a partner in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Nov
19

Beware of New Property Tax Legislation

Many states are attempting to change established law, causing commercial property taxes to skyrocket.

No one wants to be blindsided with additional tax liability. This is why many businesses belong to industry groups that closely monitor liability for income taxes. Unfortunately, these same companies rarely stay on top of legislation that may have a significant impact on their property tax liability.

It is often too late when a taxpayer learns that their tax liability for real estate has increased under a new statute or assessment practice. Property owners that fail to keep up with proposed rule changes are at risk of incurring unexpectedly high tax bills at a time when they may be least-prepared to pay them.

Property owners may take for granted that key precepts assessors use in determining taxable value are so widely held and accepted as to be immutable. Almost every state's tax law holds that a property owner pays property taxes on the asset's "real market value.," Real market value is the price a willing buyer and willing seller would agree upon in an open-market transaction

In a retail real estate sector that is still reeling from widespread store closures and mounting competition from e-commerce, the lease rate for a lease in place may not reflect market rent. Thus, it is the "fee simple" estate that is being valued for tax purposes: What rent does the market data support as of the tax assessment's date?

Valuing the fee simple estate at market rent is a significant taxpayer protection in the changing landscape of today's marketplace for retail spaces. Sales of brick-and-mortar stores have plummeted due to changing consumer spending habits, a decline in international tourism spending and a lack of investor demand for many big boxes. It is no secret that internet sales have battered the department store sector. The resulting closures of large department stores have further dampened investors' appetite for large-box spaces, and these effects have trickled down to impair the value of smaller retail spaces.

Assessors question assumptions

In the past several years, some assessing authorities have pushed to change the definition of real market value to disregard the perspective of a willing buyer in an open market, and to instead create a false value as if the property were fully leased at market rates as of the assessment date.

In Oregon, recent rules are being proposed (and the theory tested in court) with the assumption that a property can always receive a stabilized rent in the market place. Thus, an assessor would use a property's expected occupancy and market rent in using the income approach to determine the fee simple interest. The costs to get to a stabilized rent, according to the new rules, cannot be applied to discount the stabilized rent. Thus, a vacated department store, or a brand new vacant building, will be assessed as if it is receiving full market rent, without reflecting any of the costs associated to get there.

For example, the proposed rule states that it is implied in the cost approach that valuation reflect not only construction and materials but also all indirect costs, such as the cost of carrying the investment in the property after construction is complete but before stabilization is achieved, as well as all marketing costs, sales commission and any applicable holding costs to achieve a stabilized occupancy in a normal market. Thus, even though the taxpayer has not yet incurred all these expenses, they can be added to the taxable value and the taxpayer may not subtract them in arriving at market value for property tax assessment purposes.

The result is that not only will a new vacant space be valued as if it is fully rented, but a second-generation retail space may be assessed under the cost approach as if it is fully leased. The reality of lease-up costs, including holding costs and tenant improvement costs, are simply to be ignored.

The International Association of Assessing Officers (IAAO) recently published a paper titled Commercial Big-Box Retail: A Guide to Market-Based Valuation. This paper appeared to ignore generally accepted appraisal methods for valuing these types of properties and to advocate for the changes in accepted definitions of property rights that taxing entities in many states are now seeking. Importantly, when American Property Tax Counsel reviewed the IAAO's paper, its lawyers found that many of the propositions cited in the paper were based on cases or laws that had been overturned and were clearly inconsistent with established case law and law.

These attempts by the assessing authorities to change the definition of real market valuation for property taxation purposes should worry commercial property owners, and particularly owners of retail properties, given the continuing potential for prolonged vacancy. For these properties to remain viable, the owners need to mitigate all costs, including property taxes.

A reduction in property taxes can benefit a property owner significantly. Oregon has the benefit of a five-year statutory hold, with some exceptions, on a successful appeal to property taxes. Thus, a $100,000 reduction in property taxes through the appeal process could result in a $500,000 savings.

With the assessing authorities' proposed changes to the tax rules, however, market realities and real market value are compromised.

Cynthia M. Fraser is an attorney specializing in property tax and condemnation litigation at Foster Garvey, the Oregon and Washington member of American Property Tax Counsel, the national affiliation of property tax attorneys.
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Nov
18

How to Reduce Multifamily Property Taxes

Take advantage of the following opportunities for tax savings in the booming multifamily market.

With healthy multifamily market fundamentals and increasing demand from investors, apartment property values are on the rise. For owners concerned about property tax liability, however, there are still opportunities to mitigate assessments and ensure multifamily assets are taxed fairly.

Here are key considerations for common scenarios.

Property Acquisition

Whether an investor is buying a single property or a portfolio, it is wise to understand how the transaction will affect property taxes going forward. In some taxing districts, the assessors will move the value to 80%-90% of the sale price in the assessment year following an acquisition. If the sale is an arm's length, open market transaction with no unusual investment drivers, there remain few arguments against increasing taxable value to equal the sale price, less personal property.

When running income and expense projections on a potential acquisition, look to how the sale will affect taxable value. To pencil in reasonable budgets, consult with local experts who can zero in on a likely tax rate. Those who know the market can forecast local rate increases with some accuracy.

When there are non-open-market factors in a sale – such as unusual financing, tax shelter exchange considerations or a portfolio value allocation based on forecasts – there is more room to make arguments for a value based on an income approach. In discussing this approach with assessors, the greatest source of disagreement is the capitalization or cap rate used to extrapolate value from the income stream.

For apartments in the Midwest, initial cap rates can range from 4.5% to 6.5%, and assessors will often choose rates from the lower end of the range or use an average. Taxpayers who can demonstrate or work with the assessor to derive the correct cap by using appropriate comparable sales will enjoy a more reasonable value discussion.

Opportunity Zones

An opportunity zone stimulates investment within its perimeter by enabling investors to reap tax benefits on deferred capital gains and spur growth. This vehicle has been of special interest to developers of student and low-income housing. To get the full benefit of the new program, investors must decide to invest in a qualified opportunity fund (QOF) by the end of 2019.

Investors in QOFs which were formed to meet a June deadline must invest these funds into qualified property by year end. Investors that miss the deadline will be subject to IRS penalties. After 10 years of investment, 100% of the gain will be free of capital gains. This can enhance returns considerably.

The race to the year-end finish line could lead investors to initiate apartment deals that fail to meet market development yields. When looking at the values for property tax purposes, the costs of such projects driven by tax advantages can be discounted in a valuation analysis.

Procedural Concerns

Property owners' increased sophistication in challenging assessed values has led many taxing jurisdictions to use procedural arguments to shut down a petitioner's case, citing failure to comply with minute details of technical rules such as income disclosure requirements.

• In some jurisdictions, petitioners must disclose certain information for an appeal to go forward. For example, in Minnesota a petitioner that contests the assessed value of income-producing property must provide a slew of information to the county assessor by Aug. 1 of the taxes-payable year. These include: year-end financial statements for both the year of the assessment date and the prior year;
• a rent roll on or near the assessment date listing tenant names, lease start and end dates, base rent, square footage leased and vacant space;
• identification of all lease agreements not disclosed on the above rent roll, listing the tenant name, lease start and end dates, base rent and square footage leased;
• net rentable square footage of the building or buildings; and
• anticipated income and expenses in the form of a proposed budget for the year subsequent to the year of the assessment date.

The duty to disclose is strictly enforced, even if there is no prejudice to the taxing authority. In the case of an appeal for an apartment project, it would be prudent for a petitioner to clarify with the assessor in advance what data is required. Particularly if there is a commercial component to the project, where license agreements can be considered leases, a prior agreement with the assessor on what is required will remove the risk of a case ending on procedural grounds.

Seniors Housing

Many seniors housing complexes include independent living sections; assisted living areas, usually with smaller unit sizes and limited or no kitchen facilities; and memory care areas with even more limited furnishings, locked access and egress and full-time staffing by case professionals.

No matter what type of living area is involved, the monthly rental payment covers services provided to residents over and above rental of an apartment unit. These services are most intensive and comprehensive for residents in memory care, who require the most direct staff attention and receive all meals and services through the facility.

Even assisted living and independent living residents enjoy significant non-realty services, including wellness classes and other programming, spiritual services, medication dispensing, field trips for shopping or other events, onsite dining facilities and operation, and access to full-time staffing at the facility. These services are part of what residents pay, and it's important when trying to determine the real estate value for tax purposes that the service income component is excluded from the valuation analysis.

Although the market is robust for both multifamily investment sales and construction, taxpayers who apply a data-based approach with knowledge of local market conditions, procedures and opportunities can achieve a reasonable property tax bill.

Margaret A. Ford is a partner at Smith, Gendler, Shiell, Sheff, Ford & Maher P.A., the Minnesota member of American Property Tax Counsel, the national affiliation of property tax attorneys​.
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Nov
11

How Value Transfers Reduce Tax Liability

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

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

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

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

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

COST IS NOT MARKET VALUE

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

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

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

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

WHERE THE VALUE GOES

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

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

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

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

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

FIGHT FOR TRANSFERRED VALUE

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

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

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

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