​Investors should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class, says attorney Kieran Jennings.

Recently, The New York Times published an article on property taxes imposed on retailers under the headline "As Big Retailers Seek to Cut Their Tax Bills, Towns Bear the Brunt." This and similar articles question the fairness of how retailers have reduced their tax bills by using sales of unoccupied stores as comparable transactions to establish the assessed value for an occupied store.

The local government has cried foul, and the article concentrates on the perceived end result―lost revenue for government coffers.

What is missing from the article is basic tax law, which holds that all taxpayers in a given class must be taxed uniformly. Thus, the series of bad decisions that led local government to overtax retailers made communities dependent on inflated revenue. The initial mistake many assessors made was to seize upon sales prices associated with leased retail stores without critically examining the transactions.

Investors, and taxpayers in general, should be wary when taxing authorities single out properties to be assessed in a method that is inconsistent with the treatment of other taxpayers in the same class.

Most state constitutions specify that taxes must be uniformly assessed, which requires assessors to follow the same rules for all taxpayers within a class. At the most simplistic level, the rules of the game must be consistently applied to all and not changed to affect the outcome.

To understand how equally applied rules achieve fair taxation of property, bear in mind this fundamental truth: The assessor's goal is to measure the value of real estate only. Taxing entities then use that value to determine the tax. A lack of well-thought-out rules and procedures created the problem of non-uniform assessment.

Many states don't even have a clear definition of what they are trying to measure. States use terms such as "true value" or "true market value" without any further defining language. For most people, fair value simply means what a home would sell for in an open-market transaction. But commercial real estate is not that simple and requires clear definitions applied uniformly to all taxpayers.

Commercial property values are influenced by many factors unrelated to real estate. Consider how, under various circumstances, the same property might sell for wildly different values: An owner-occupied property will sell based on what the market will pay for the building once it is vacant, either for the new owner to occupy or as an investment for the buyer to lease-out at market terms.

The same property, were it leased at an above-market rental rate or to a highly credit-worthy tenant, functions much like a bond and will sell based on a market capitalization rate and for a greater price than the owner-occupied property.

Finally, the same property leased with long-term, below-market lease terms or a less credit-worthy tenant might sell for less than the owner-occupied price or the above-market-leased example. In each scenario, the same property sells for different amounts. Without a clear set of guidelines, establishing value based on sales price would be inconsistent even for a single property, much less an entire class.

Of the three scenarios, the only method that can be replicated consistently and applied to owners of both leased and owner-occupied real estate alike is that of the owner-occupied property. Owner-occupied interest is the unencumbered, fee-simple interest, which makes it the measuring stick common to all taxpayers. All other interests are influenced by non-real-estate factors such as lease terms or business value.

Adding to the confusion is the ever-changing commercial real estate sector, where market data is full of sales that include non-real-estate influences. The single-tenant market, for example, has evolved from almost exclusively retailer occupancy to include specialty uses and even nursing homes and hospitals.

The assessment goal should be to measure the real estate value alone, ensuring that all taxpayers are taxed with the same measuring stick, but confusion comes in when the sales alone don't indicate real estate value. Leased sales indicate the value of the real estate along with the tenant's credit-worthiness, the life of the lease and a host of other factors that can include enterprise zones and outside influences.

The court cases that are clarifying the methodology and the measuring stick appear to reduce assessments, when they are actually correcting the assessments and requiring assessors to value the same interests for all taxpayers. Defining terms and ensuring rule uniformity protects all taxpayers. There is no foul to be called and the losses affecting some local governments are the result of their own mistakes.

The cure is simple, but the short-term pain for community coffers is significant. States must establish clear definitions and guidelines around property rights so that assessors can value all real estate without encumbrances. Local governments cannot rely on a single taxpayer subset to carry the tax burden.

​True to campaign promises, the new Cook County assessor has proposed sweeping legislation that borrows the most burdensome tax requirements and penalties from jurisdictions across the country. But will this enhance transparency or simply saddle taxpayers with inaccurate assessments and the need for costly appeals?

The 2018 race for Cook County Assessor ended in Fritz Kaegi beating out incumbent and long-time political powerhouse Joseph Berrios. Kaegi's campaign promises targeted the "insider" game of property tax appeals and proposed to bring fairness and transparency to the Illinois property tax appeal system.

The proposed requirements would only be imposed on commercial or income-producing properties worth more than $400,000, or residential properties with seven or more units worth more than $1 million. Residential properties with six units or less, as well as mixed-use commercial/residential buildings with six or fewer apartment units and less than 20,000 square feet of commercial area, are exempt from reporting income data.

In Cook County, these commercial properties will be required to submit income and expense data to the assessor prior to July 1 each year, and attest to the truthfulness of such information. Counties outside of Cook County may adopt the same requirement.

Property owners who fail to file the required information may receive a notice from the assessor demanding its submittal. If the taxpayer fails to report the income pursuant to the notice, the taxpayer will be fined 2 percent of the previous year's total tax bill. If the taxpayer still does not submit evidence within 120 days of the original notice, the proposal adds a second penalty of 2.5 percent of the prior year's tax bill.

As if these financial penalties were not enough, the taxpayer who fails to provide the information within 120 days is precluded from appealing the subject property's tax assessment. Furthermore, the Cook County State's Attorney's office is granted the right to subpoena the income and expense data from the tax payer on an annual basis.

None of the legislation eliminates the right to appeal to the Board of Review, however.

So, will the proposed statute bring fairness and transparency to the appeal process? No.

Round hole, square peg

The requirement to file income and expense data is not revolutionary. In many cases, taxpayers file appeals based directly on the property's income data rather than incur appraisal expenses. On the other hand, income-producing properties that commission an appraisal will provide the income and expense data to the appraiser in order to explain any differences between the actual rents in the subject property and the market rents used to calculate the assessment. Thus, the new rules will not necessarily bring more transparency to the values of multimillion-dollar commercial properties.

For the institutional investor, the greatest concern about the proposal is the validity and application of the collected income and expense data. As the old saying goes "garbage in, garbage out."

The assessor claims that the collection and aggregation of data directly from taxpayers will help identify the true rental market value of specific real estate. The concern is that taxpayers will be reporting a variety of unadjusted rents rather than market rates. Market rates take into account the differences between gross, modified and triple net leases, as well as tenant improvements, concessions, length of lease, sale-leasebacks and a host of other factors. Without adjustment to market rates, the data will be incorrect and the assessments will be inflated. This will produce a higher rate of appeal on an annual basis and impose greater appeal burdens on all involved.

Furthermore, the new requirements will bring the greatest harm to smaller commercial investors who may not be filing property tax appeals at all. Many of these are mom-and-pop organizations that keep handwritten ledgers and have market values between $400,000 and $1 million. The annual reporting requirement and respective penalties would be financially burdensome to taxpayers in this group, many of whom never undertook the expense of filing an appeal. Now those taxpayers may be open to valuation increases on an annual basis and have to spend money on appraisals and attorney representation.

And transparency?

The proposed statue prohibits "non-personal income and expense data" the assessor collects from being accessed through Freedom of Information Act searches. Does this indicate that the data sets the assessor produces cannot be analyzed by the taxpayer for accuracy? Where is the fairness and transparency in that?

If the statute passes, the hurdle for Illinois taxpayers will be to clearly identify the difference between market rents and actual rents for each of their properties, which may result in extremely burdensome requirements and penalties. The mandated steps may require intricate analysis and could result in property owners expending time and money responding to annual notices for documentation, fines for noncompliance, and the inability to challenge illegal assessments as a right.

Much of the income-and-expense statements, rent rolls and other data the assessor seeks are already available in documentation currently being submitted in support of annual appeals. Based upon this readily available data, the assessor should be able to generate guidelines that reflect current rental rates, occupancy levels and capitalization rates.

If Cook County taxes need reform, this is not the reform.

​The FTZ Act prohibits state and local taxes on tangible personal property.  Here's what you should know about the potential for reducing your tax bill.

Foreign-trade zones can offer substantial tax savings for businesses involved in various aspects of manufacturing and international trade. While there are costs involved in setting up and maintaining such a zone, the prospect of escalating trade wars is spurring companies to explore the FTZ designation as a potential cost-control measure.

First, some background. FTZs are the U.S. equivalent of what are known internationally as free trade zones. Authorized under the Foreign Trade Zones Act of 1934, they are usually in or near U.S. Customs and Border Protection ports of entry, and are generally considered outside CBP control. Many communities have integrated these zones into state or local economic development incentive programs.

Broadly speaking, FTZs are designed to stimulate economic growth and development. In an expanding global market, countries increasingly compete for capital, industry, and jobs, and FTZs promote American competitiveness by encouraging companies to maintain and expand their U.S. operations. The zones accomplish this by removing certain disincentives associated with operating in the U.S.

The best-known incentive is designed to level costs among domestic and foreign- manufactured goods. For a product manufactured in a foreign country and imported to the United States, the duty is based on the finished product rather than on its individual parts, materials, or components.

Domestic manufacturers must often pay duties on multiple parts, materials, or components that are imported to be incorporated into a finished product. When those duty payments are added together, the cost of the finished product is higher than for comparable finished goods. FTZs correct this imbalance by assessing duties on products manufactured in an FTZ as if they were manufactured abroad.

Companies operating in FTZs enjoy a number of other benefits:

• No duties or quotas on re-exports

• Deferred customs duties and federal excise taxes on imports

• Streamlined customs procedures

• Exemption from certain state and local taxes

These benefits become increasingly valuable to domestic companies during trade wars, particularly when the disputants impose steep tariffs on manufacturing parts, materials, and components.

STATE AND LOCAL FTZ RULES

FTZs are subject to the laws and regulations of the U.S., as well as those of the states and communities in which they are located, with one significant exception: The Foreign-Trade Zone Act specifically prohibits state and local ad valorem ("on the value") taxation of imported, tangible personal property stored or processed in one of these zones, or of property produced in the United States and held in the zone for export.

Several states, including Arkansas, Kentucky, Louisiana, Maryland, Mississippi, Oklahoma, Texas, Virginia and West Virginia, impose ad valorem tax on business inventory. In a handful of other states, including Alaska, Georgia, Massachusetts, and Michigan, some jurisdictions tax some inventories. But even in these states, most legislatures have carved out "freeport" exemptions from ad valorem taxes on merchandise being shipped through the state.

The problem is, the longer it takes for the merchandise to be shipped out of state, the greater the temptation for an enterprising tax assessor to conclude that the merchandise is no longer actively in transit. In such cases, the exemption may no longer apply and the merchandise could become subject to an inventory ad valorem tax.

FTZs may offer a safe harbor from these taxes. Foreign and domestic merchandise may be moved into a zone for operations, including storage, exhibition, assembly, manufacturing, and processing. Such merchandise may remain in a zone indefinitely, whether or not it is subject to duties. And, while no retail trade of foreign merchandise may be conducted in an FTZ, foreign and domestic merchandise may be stored, examined, sampled, and exhibited in the zone.

Of course, there is a catch. When a proposed FTZ designation could result in a reduction to local tax collections, the zone's governing authority must consider the potential impact on local finances. Specifically, an applicant must identify the local taxes for which collections would be affected, and provide documentation that the affected taxing jurisdictions do not oppose the FTZ designation. Importantly, in jurisdictions that already have "freeport" exemptions to ad valorem taxes, the adverse impact would be limited only to the amount of ad valorem taxes imposed on inventory that is determined by a tax assessor to have come to rest in the state, such that it is no longer subject to the "freeport" exemption.

There are costs associated with FTZs, including application fees and assessments as well as operating fees to maintain the designation. Therefore, individual companies must conduct their own cost/benefit analyses and determine whether these zones are right for them. A competent legal or tax advisor can help to project initial and ongoing costs.

Considering the other trade uncertainties currently buffeting manufacturers, eliminating ad valorem tax exposure alone may warrant using an FTZ.

​Assessors too often value newly constructed apartments as fully occupied, producing excessive assessments.

Developers frequently ask how to estimate property taxes on newly constructed multifamily properties, and tax assessors often provide an easy answer by adding up the value of building permits or by projecting the project's value when fully rented. However, this seemingly simple question grows complex when the assessor's valuation date precedes full occupancy and the ramifications of a wrong answer can linger for years.

Consider these points to value a new multifamily project more accurately.

Valuation Methods

Charged with valuing hundreds or thousands of parcels, assessors often seek a quick way to value a new multifamily project.

The cost approach offers the quickest and easiest route for the assessor, who estimates the current expense to construct an identical structure. One way to do this on a new project is to add the value of the building permits to the land value.

While building costs are clearly a factor in the decision to build, the cost approach ignores the market preference to value income-producing projects based primarily on income.

The assessor's second-easiest option is to rely on an appraisal's stabilization value and ignore the time and cost required to achieve stabilization. In valuing a not-yet-built multifamily project using an income approach, appraisers preparing a financing appraisal should, but don't always, calculate two different values: the "at completion" value and the "stabilized" value.

"At completion" is the project's value when construction is complete but prior to being fully leased. The prospective market value, or "as stabilized," reflects the property's projected market worth when, and if, it achieves stabilized occupancy.

The Dictionary of Real Estate defines stabilized value in terms of the expected occupancy of a property in its particular market, considering current and forecast supply and demand, and assuming it is priced at market rent. To determine a property's fair market value prior to stabilization, one must account for the monetary loss the owner will incur prior to stabilization.

Development Issues

Improvements generally trigger reassessment. The assessor's statutorily mandated valuation date generally ignores the development calendar's key milestones, most importantly the construction commencement, completion and revenue stabilization dates.

The developer makes assumptions during the development process, calculating the cost of building and operating the improvements as well as the rents that can be achieved. This calculation serves as the basis for a pro forma of an income and expense analysis of the project when fully leased.

Construction loans reflect building costs and subsequent time and money needed to achieve full lease-out or stabilization. Banking regulations require the lender to obtain an appraisal. The completed, but not yet stabilized, project incurs costs in the form of income not received during initial leasing, until it reaches stabilization.

Permanent financing depends on the stabilized value, which, in turn, depends on the project's income. Appraisals for permanent loan commitments obtained prior to the project's completion use a prospective valuation date and must contain various assumptions as to the property's financial condition on that prospective date.

The FDIC's Interagency Appraisal and Evaluation Guidelines authorize using a prospective market value in valuing a property interest for a credit decision. The Uniform System of Professional Appraisal Practices requires disclosure of assumptions in an appraisal with a prospective market value, as of an effective date subsequent to the appraisal report's date.

Assumptions regarding the anticipated rent at stabilization and the time required to lease the property are key to calculating stabilized value. Also critical are incentives the owner may offer prospective tenants during lease-up, and the project's projected income once fully leased. The appraisal should clearly disclose these assumptions, but they can still prove incorrect.

Clear disclosure of assumptions is critical. Unfortunately, many appraisers fail to adequately disclose their assumptions, and shortcut to the project's stabilized value.

Valuation Dates

Most state statutes prohibit taxation of improvements while under construction. The project usually comes on line for tax purposes after completion but prior to stabilization.

Being mandated by statute, the valuation date often does not account for where the multifamily project is on the spectrum between completion and stabilization. Unsophisticated assessors charged with valuing these projects often employ mass-appraisal techniques and may value the asset similarly to the market's stabilized properties.

Statutory Caps

Some states cap potential increases in tax value, which may magnify impact of the initial tax valuation. Caps limit increases that would otherwise bring values up to the market. For example, South Carolina properties undergo countywide reassessment every five years, but property values ordinarily cannot increase by more than 15 percent from the previously determined value.

Assessors know that a project's value at completion will nearly always be lower than its stabilized value because stabilization takes time and costs money. Competition may lower the project's achievable income, too. This knowledge can spur assessors to reach for stabilized values regardless of whether the project is yet stabilized. This taxes the unrealized, additional value between completion and stabilized levels.

A Matter of Time

All of the above considerations involve a timing disconnect between the property's actual condition on the statutorily mandated valuation date and its estimated future value based on fallible projections by the lender, developer or assessor. Axiomatically, assumptions don't always hold true. Lease-up may take longer than expected and may require concessions that increase cost. In over-built markets, the stabilized income may be lower than originally anticipated.

Charged with calculating true or fair market value as of a statutorily mandated valuation date, the assessor should examine how the market would value the property as of that date. If the asset has not achieved stabilization, the assessor should discount appropriately for time and financial costs required to achieve stabilization.  That is what the market would do, and is what the assessor is statutorily obligated to do.

And that should be the answer to the seemingly simple question of how to value newly constructed multifamily projects for tax purposes.

​Here's what taxpayers should do if the tax controversy now brewing causes large property tax increases

Recent headlines questioning the taxable values of Atlanta-area commercial properties may threaten taxpayers throughout Fulton County with a heightened risk of increased assessments.

Changes in the Midtown Improvement District, which extends northward from North Avenue and along both sides of West Peachtree and eastward, are rapidly reshaping the Atlanta skyline. Multiple new buildings under construction rise 19 to 32 stories, ushering in more than 2,000 new apartment units as well as hotel and office uses.

Amid this intense construction, Fulton County tax assessors have come under fire in newspaper and broadcast news reports that showed assessed taxable values were well below the acquisition prices paid for many commercial properties. Both Atlanta and Fulton County have ordered audits to determine whether assessors consistently undervalued properties, resulting in lost revenue.

While it may be unsurprising that assessors failed to keep up with rapidly changing market pricing in a development hotspot like Midtown, the news coverage and government scrutiny may pressure assessors to increase commercial assessments across the board. Owners of both newly constructed and older properties should diligently review the county's tax assessment notices, sent out each spring, to determine whether they should appeal their assessed values.

Know the assessment process

Understanding the permissible approaches to valuation is key for the taxpayer to determine whether to appeal an assessment. The two most commonly used methods are the income approach and the market or sales comparison approach, both of which can be problematic if incorrectly applied by the county assessor.

Assessors typically value apartments and office buildings using the income approach. Initially, however, assessors use mass appraisal methods that may not reflect the specific financial realities of the individual property. Taxpayers should examine each of the various components of the county's income model and question whether each element of the formula is appropriately applied to their property.

By utilizing data from the market, has the assessor overestimated the rental rates for the property? Property owners should analyze and discern whether it is beneficial to provide the previous year's rent roll to the assessor in order to argue that the county's model rental rate is inaccurate for their property. An older complex or building may have new competition from a recently built property offering up-to-date amenities. Not only will the older property be at a disadvantage to charge premium rents, but the newer construction is also driving its taxes higher.

Has the assessor used a market occupancy rate that does not correctly indicate the property's occupancy level? In order for the income approach to accurately achieve both physical and economic occupancy, the vacancy and collection loss should take into account both the occupancy rate and concessions that the owner provides to renters to maximize occupancy. Again, in a fluctuating market with new construction competing against old, occupancy rates can be affected.

In using market data, has the assessor underestimated the expenses for the property? Perhaps the expense ratio used is inappropriate for the property. If so, property owners can demonstrate this by providing the previous year's income and expense statement to the assessor, differentiating their property from the mass appraisal model.

A common area of disagreement is the capitalization rate. A capitalization rate is the ratio of net operating income to property asset value. Has the assessor used a cap rate that is derived incorrectly from sales of properties that are not comparable to the taxpayer's property?

Has the assessor properly added in the effective tax rate to the reported base cap rate from the comparable sales because the real estate taxes were not included in his allowable expenses? If the effective tax rate is not added to the base cap rate, and real estate taxes are not included in the expenses, the result is a lower cap rate, and thus, an artificially and incorrectly higher value. An analysis of the accurate application of the sales comparison or market approach is helpful in making the determination of the appropriate cap rate.

Many factors go in to determining if sales are sufficiently similar and can be relied upon. The comparable sales used should be of a similar age as the subject property. Older properties usually command a lower price per unit or lower price per square foot than newly constructed properties.

The comparable sales used should be similar in square footage to the subject property, with similar square footages in the various units within the property, because larger average unit size usually generates higher rents and also results in a quicker lease-up.

Consider the type of purchaser involved in the comparable sale transactions. Private investors typically pay less for properties than institutional purchasers such as real estate investment trusts because REITs are able to obtain lower-cost loans.

Similarly, if below-market-rate financing was already in place and the buyer was able to assume the loan, then the sale price may have been artificially inflated. Another circumstance to examine is, if the seller provided a significant amount of financing in the sale, there may have been unusually favorable financing terms; if so, the sales price must be adjusted.

Another aspect to investigate is the existence or lack of substantial deferred maintenance at the time of sale in comparison to the subject property. The necessity for additional capital expenditures after a purchase can affect the purchase price.

It is helpful to inquire into the effective real estate tax rates of the sold properties in order to determine if they are sufficiently similar to the subject property. Jurisdictions or taxing districts with lower tax rates can cause properties to sell for higher prices. Taxing neighborhoods with higher tax rates tend to generate sales with lower values, and thus, higher cap rates.

All commercial real property owners in Fulton County should carefully examine their tax assessment notices, because higher valuations by county assessors may be on the horizon. Property owners do not want to pay sky-high taxes based on what may be reflexive assessments stemming from the latest headlines.

​ While Texas solved the problem, your state may not have addressed the issue.

Many states tax business personal property, a classification that includes furniture, fixtures, equipment, machinery and, in some states, inventory. Whatever the jurisdiction, the values of business personal property and real estate can easily be conflated in ad valorem taxation, unfairly burdening the taxpayer with an additional appraisal and/or taxation.

If you live and work in a state that doesn't tax business personal property, it may be included with the taxes on your real estate anyway. If you are in a state that taxes personal property, you might be taxed for it twice. While it seems contrary to acceptable appraisal practice to include personal property in the real estate value and then to additionally appraise and/or tax the same items, it does happen.

The Texas Legislature wrestled with this problem of additional valuation and taxation for more than a decade. That process and the resulting tax law offer important lessons that may help taxpayers and lawmakers in other states.

Texas gets personal

In 1999, the Texas Legislature enacted Section 23.24, titled "Furniture, Fixtures and Equipment," as a new statute in the State Tax Code. Prior to its enactment, furniture, fixtures and equipment were often included in the appraised value of income-producing real estate for ad valorem taxation. They were also subject to a separate business personal property tax. Section 23.24 eliminates this double taxation as long as the method used to value the real estate takes the business personal property into account.

There are many different kinds of property but only a few approaches to valuation. When the values of real property and personal property are mixed, it is usually because they are being assessed as components of an operating business using the income approach. Hotels and motels, nursing homes, restaurants and convenience stores are among the property types at greatest risk of having real estate and personal property values combined.

An assessor valuing the real estate component of an operating business will likely use the income approach. This method bases value on the income stream a business can generate using the real estate and personal property as components of a business enterprise.

A hotel doesn't have a business without beds, and a restaurant doesn't have a business without tables and chairs. As such, a value determined using the income approach is going to include the value of the real estate and the personal property, as both contribute value to the enterprise's income stream. It's clear to see how using the income approach can conflate real and personal property value into one.

The cost approach keeps those values separate. Using this method, an assessor or appraiser looks only at the value of the land as if it were vacant, then adds the value of improvements based on the cost to construct those improvements minus any depreciation. There is no accounting for, nor any risk of conflating, the business personal property within the real estate while using this approach.

In many instances, however, appraisal districts that were not using the cost approach – or had switched from the cost approach to the income approach from one year to the next – were still additionally appraising and even maintaining a separate account for the business personal property. This would seemingly violate Section 23.24.

Many appraisal districts disagreed, claiming that a separate account for business personal property enabled them to deduct that amount from the real estate. In doing so, they believed that there would be no additional burden on the owner, who would only be paying taxes once on the personal property.

While the tax liability may not be increased, an appraisal district with a separate account for personal property still creates burdens for the owner. The taxpayer is required to file a rendition on the personal property stating either "the property owner's good faith estimate of market value of the property or, at the option of the property owner, the historical cost when new and the year of the acquisition of the property."

If owners fail to file this rendition on personal property already being accounted for in the value of the real estate, they are subject to a penalty that increases their tax liability by 10 percent. It hardly seemed fair that the taxpayer should have these obligations and liabilities regarding property that was already intertwined with the value and tax for the real estate. Two consecutive legislatures agreed.

In 2009, lawmakers created a subsection to Section 23.24. This statute intended to exorcise the appraisal districts' method of having a second account for the personal property and/or attempting to separate or subtract the value of the personal from the real when both values had already been combined in the real estate. Some appraisal districts were still requiring renditions (and seeking penalties for failure to do so) on property value already captured with the real estate.

In 2011, the next legislature removed the additional and needless burden to render business personal property that is not to be appraised separately from real property in the first place. The law now says that if business personal property is being appraised under Section 23.24, then the owner is not required to render anything.

Implications for other states

Check your state's laws regarding the taxation of personal property and make sure you're not already paying those taxes on the real estate.

Texas and Oklahoma tax inventory as well as business personal property, and not only is the tax present, it's prevalent. In 2016, personal property tax made up 12 percent of the property tax base in Texas and nearly 23 percent of Oklahoma's property tax base.

Whether personal property tax is present and/or prevalent in your state, make sure you are not paying personal property taxes where it isn't taxable, or paying it twice in jurisdictions where it is taxable.

Tax courts don't always recognize market value in setting property tax assessments.

Most real estate is taxed ad valorem, or according to the value. The theory is that each person is taxed on the value of the real property they own.

The New Jersey Constitution (Article VIII, Section 1, paragraph 1) stipulates that property is to be assessed for taxation by general laws and uniform rules, and that all non-agricultural real property must be assessed according to the same value standard.

Our statutes define the standard of value as the true property value. We call this market value, or the most probable price a property will bring in a competitive and open market under conditions requisite to a fair sale. That assumes the buyer and seller are each acting prudently and knowledgeably, and that the price is unaffected by undue stimulus.

In 2005, the state Tax Court, in a General Motors case, openly admitted it was making a determination that the highest and best use of the property was as an auto assembly facility. By this determination, the court set public policy indicating that this highest and best use fairly and equitably distributed the property tax burden.

In this case the court felt it was necessary to conclude the highest and best use of the property at issue was an auto assembly plant because to do otherwise may allow features of the property to go untaxed and therefore lower the value of the plant. The court also stated that this determination was consistent with and effectuates the public policy of fairly and equitably distributing the property tax burden. All of this was concluded while the market data suggested a different result, given that no auto manufacturing facility had ever before been sold to another automobile manufacturer. Further, by law, the tax court's role is to determine value, not to redistribute the tax burden.

The history of the Tax Court has, in practice if not in theory, interpreted the constitution and statutes of real property taxation to find value in a uniform and stabilized manner. In other words, although the market may vary over a period of years under review, the court would attempt to stabilize the effect of the differences when rendering opinions.

The Tax Court would also set precedent by using methods of valuation not normally used in the marketplace because it deemed the data before it at trial to be lacking. It has, for example, applied a cost approach to determine value when a buyer would purchase a property based on an income approach. This is common in court decisions, but often runs afoul of true market motivations and distorts the conclusion of value. The more the courts reach these types of decisions, the further away they move from concluding market value.

The court's attempt to carry these principles forward has appeared in various ways over the years. As early as 1996, in a case involving a super-regional mall with anchors not separately assessed, the Tax Court deemed the income approach inappropriate to value the stores and instead valued the stores on a cost approach. Today, the legacy of that decision requires plaintiffs to present a cost approach, which is not evidence of market value. This may well distort a property's valuation.

Issues such as capitalization rates are also problematic for certain assets in Tax Courts findings. Over the years, court precedent has set rates that often do not reflect the market. This is especially evident today when valuing regional malls classified as B or C grade. The market capitalization rates are well over those the courts have historically found. Although transactions verify this market data as accurate, the courts fail to recognize it, making it difficult for plaintiffs to prevail with values based on actual, transactional data.

In January 2018, after a number of decisions that rejected plaintiffs' approach, our Tax Court appears to have taken some pause. It recognized that by rejecting proofs from the market and data forwarded by taxpayers, it was ultimately failing to conclude to warranted assessment adjustments.

It stated:

"there has been some criticism of late, that the Tax Court perhaps has raised the bar for meeting the standard of proof too high in property tax appeals, given arguendo, what could be viewed as a growing trend seen in a number of recent decisions, where the court rejected expert opinions and declined to come to value. While such a suggestion may give the Tax Court pause for self-examination and reflection, it must not serve to invite expert appraisers to abrogate their responsibility of providing the court with 'an explanation of the methodology and assumptions used…'"

The quote seems to recognize that the proof bar was getting so high that a plaintiff could never prove its case. A more realistic view of the proofs provided by a taxpayer comes with it the recognition that market data and actions from market participants are the touchstones of value that should establish our assessments.

Confusion Regarding Tax Code's Rendition Requirements Creates Penalty Trap

A provision in the Texas Property Tax Code requires hotel assessments based on an income analysis to include personal property. However, misunderstanding associated rendition requirements can cause unexpected penalties for hotel owners.

In Texas, both real and personal property are taxed at 100 percent of assessed value. Prior to 1999, a hotel's real and personal property were valued under separate accounts. A hotel's income and expense stream, however, incorporates value generated by both real and personal property.

For instance, a nightly hotel room rate covers the rent for the real property (the room itself) as well as personal property (the furniture and fixtures in the room). This blended income formerly created unique challenges when using the income approach to value hotels for property tax assessments.

In a move toward simplification and to protect against potential double taxation, lawmakers added Section 23.24 to the tax code in 1999. This provision prevents furniture, fixtures and equipment included in a real property valuation from being taxed a second time under a separate, personal property account. The statute was amended in 2009 to stipulate that, for properties such as hotels, the value of real and personal property must be combined into one assessment if the assessor uses an income analysis.

Specifically, Section 23.24(b) states that "in determining the market value of the real property appraised on the basis of rental income, the chief appraiser may not separately appraise or take into account any personal property valued as a portion of the income of the real property, and the market value of the real property must include the combined value of the real property and the personal property."

Section 23.24 simplifies the valuation process for hotels valued under an income analysis, presuming that total income reflects the contributory value of the real and personal property and that separating the two is an unnecessary step when both portions are taxed at a 100 percent assessment ratio.

The legislature amended Section 22.01 in 2011 to include subsection "m," which provides that "a person is not required to render for taxation personal property appraised under Section 23.24."

Taxpayer pitfall

As a result of these provisions, many hotel owners assume that their personal property will be included in the real property assessment and do not submit annual renditions to county appraisal districts. But what happens if a jurisdiction does not value a hotel using the income approach?

The caveat in Section 23.24 is that the property is valued "on the basis of rental income." Because the income approach is just one of three recognized approaches to value, this statute does not eliminate the independent consideration of personal property in ad valorem taxation for hotels in Texas.

Although assessors value most hotels based on income, there are several common scenarios in which they may use an alternative method, triggering the creation or continuation of a separate personal property account.

Jurisdictions often value newly constructed hotels using the cost approach during the first one to two years of operation, prior to stabilization. Harris County almost exclusively values hotels on the cost approach for the first year following construction.

Hotels that have been in operation for some time but have reached a point of significant renovation or decline in value may also be valued using the cost approach. In such scenarios, the assessor will value personal property under a separate account, and may require the property owner to submit a personal property rendition report.

Failure to render in a timely fashion results in a penalty equivalent to 10 percent of the total taxes due. Unfortunately, the hotel owner is often unaware of rendition requirements until they are penalized for a late rendition.

Rendition required

The following example illustrates how incorrect assumptions about an assessor's valuation methodology can result in unexpected rendition penalties.

Let's assume the assessor has valued a hotel under an income analysis since the taxpayer acquired it in 2010. Based upon this history and prior interactions with the assessor, the owner did not file a personal property rendition with the county appraisal district for tax year 2018.

The property had suffered a significant decline in performance over the past few years despite dramatic increases in land value in the area. After reviewing the documentation provided, the assessor decides to value the hotel at land value, with a minimal contributory value assigned to the improvements.

Since this approach is based upon a cost analysis and not an income approach as in prior years, Section 23.24(b) no longer applies. The switch in methodology triggers the creation of a separate business personal property account for the hotel.

Because the taxpayer's discussions with the assessor begin at an informal hearing after the rendition deadline, the owner does not learn of the change in methodology or resulting new personal property account until the opportunity to comply has passed. Consequently, the taxpayer incurs a 10 percent penalty for failure to file a timely personal property rendition.

An ounce of prevention

It can be challenging to establish complete clarity on an assessor's methodology prior to the rendition deadline. As in the previous example, scheduled discussions with assessors often occur after the deadline. A hotel owner may choose to file a protective rendition to avoid the possibility of unexpected penalties.

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​What You Need to Know to Successfully Appeal Your Inordinate Property Taxes

For some time, owners and operators of seniors housing properties have been aware of the staggering demographic statistics, such as the Census Bureau's projection that the baby boomer population will exceed 61 million when the youngest boomers reach 65 in 2029. This is truly the Silver Tsunami. Yet, even seniors housing professionals may be surprised by excessive property tax assessments that break otherwise carefully constructed budgets.

Before discussing what seniors housing owners can do to combat an excessive property tax assessment, it will help to review why some taxpayers will receive such unwelcome notifications. Factors include the large and increasing number and variety of seniors housing projects, coupled with the mass-appraisal methods that assessors typically employ.

With tens of thousands of units constructed each year, the country now has over 3 million seniors housing units ranging from independent living to assisted living, memory care and/or nursing care. Appropriate assessment methods depend on whether a property is an all-encompassing, continuing care retirement community; freestanding with only one component (such as independent living only); or comprising several (but not all) of these subtypes.

Unfortunately, assessors with limited resources usually use a cost-based methodology that is cost-effective for valuing a large number of properties. That may work for residential assessments in areas with similar homes, but given the significant differences between seniors housing properties, this approach can create an enormous tax problem for taxpayers who own seniors housing.

An outrageous assessment

In one recent case, the owner of a newly constructed property was shocked to receive an assessment valuing the property about 30 percent above its actual cost.The resulting taxes would have exceeded the owner's budget by over $250,000, not only ruining cash flow, but also destroying more than $2 million of market value.

Fortunately, there are measures taxpayers can take to counter excessive assessments. A critical initial step is to confirm any appeal deadline. Not only do rules differ across the country, but in many states the appeal deadline depends on when the notice is sent.

Further complicating this point is that more than one formal appeal may need to be filed, and taxpayers often have a narrow window within which to file. Generally, if a taxpayer receives a notice and misses a required appeal deadline, there are no second chances for that tax year.

Other important steps are to determine the applicable value standard and the assessment's basis. Usually (but not always) the standard will be market value, or the probable cash-equivalent price the property would fetch if buyer and seller are knowledgeable and acting freely. To determine that value, the assessor usually will have used an incomplete and improper cost approach that only adjusted for physical depreciation.

For these typical cases where the assessor has estimated market value using a flawed cost approach, drilling down deep into the assessor's cost methodology may produce a gusher of tax savings. In the aforementioned case, the assessor had used the costs for constructing a very expensive skilled nursing facility. Correctly using the assessor's cost estimator service for the subject property, which was mostly comprised of independent living units, reduced the cost by about $10 million.

Additionally, an assessor's cost-based valuation often will only account for depreciation from the property's physical condition. A proper cost approach must also account for any functional or external obsolescence.

Functional obsolescence can be substantial, especially for older properties, because consumer preferences change over time. What consumers may have desired years ago may now constitute a poor offering.

External obsolescence, which is often due to adverse economic conditions, can impact a property regardless of its age. For example, there will be external obsolescence if new properties overwhelm market demand in an area, or if the inevitable next economic downturn lowers market values.

Other scenarios

While atypical, sometimes assessors will use an income approach or sales comparison approach to value seniors housing properties. As with the cost approach, those approaches introduce many ways for assessors to reach erroneous and excessive value conclusions. One potentially large error is valuing the entire business and failing to remove the value attributable to services, intangibles or personal property.

In the previously mentioned case, the taxpayer's appraiser used the income approach and concluded that the seniors housing property had a total business value of approximately $22 million. The appraiser then determined that about $1 million of that value was attributable to services and intangibles and about $800,000 was attributable to tangible personal property as shown in the table below.

In a similar vein, the Ohio Supreme Court recently reversed the Ohio Board of Tax Appeals in the case of a nursing home property where a taxpayer's appraiser had determined that only about sixty-two percent of the total paid for all assets was for the real property. The Board of Tax Appeals had summarily rejected the appraiser's analysis as a matter of principle. The Ohio Supreme Court reversed and ordered the Board to reconsider the appraiser's analysis, and determine what amount, if any, should be allocated to items other than real estate.

These cases underscore that an assessor who uses the income or sales comparison approach and mistakenly values the entire business, rather than the real property alone, can improperly inflate a real property assessment by a material amount.

Another step taxpayers can take to achieve tax justice is to involve experienced tax professionals and appraisers. As the above analysis shows, property tax valuation appeals have many procedural nuances as well as legal and factual issues that must be addressed. In addition, in some jurisdictions there may be a basis to obtain relief based on the assessments of comparable properties.

As the inevitable Silver Tsunami inundates markets, there will be more seniors housing properties and more instances of excessive tax assessments. To the extent that the surge in the elderly population depletes local government finances, whether due to government pension plan shortfalls or otherwise, there should be no surprise if property tax bills increase.

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Knowing what to look for in monitoring your assessments can help avoid over taxation.

As robust occupancies and escalating investor demand in many markets drive up property tax bills for multifamily housing, apartment owners must continue to monitor their assessments to avoid overtaxation. Knowing what to look for can ease this task, and the place to start is with a firm grasp of the assessor's methodology.

Many taxpayers are unaware that assessors typically use a mass appraisal technique to derive assessments without referencing or even collecting details about a property's unique characteristics or performance. Property owners who understand the mass appraisal procedure have a distinct advantage in identifying assessment errors, and this knowledge can inform the apartment owner's arguments when they choose to fight excessive valuations.

Rooted in Generalities
The burden on appraisers to generate thousands of property values, often annually, is colossal. For this reason, assessors determine most market values for assessment purposes through mass appraisal, which is the process of valuing a group of properties as of a given date using common data, standardized methods, and statistical testing. Assessors using mass appraisal rely upon valuation equations, tables, and schedules developed through mathematical analysis of market data.

Mass appraisal analysis begins with assigning properties to classes or strata based on highest and best use. Valuation models are created for defined property groups, such as industrial or office, and are then calibrated to reflect the market factors for that specific market or submarket.

The International Association of Assessing Officers (IAAO) sets mass appraisal standards for assessors, by which an assessor can appraise the fee simple interest in property at market value. These standards set the preferred methods for mass application of the three traditional approaches to value (cost, sales comparison, and income). Armed with this information, apartment owners can attack mass appraisal procedures that result in values that don't reflect a property's true market value.

Property Data Errors
IAAO standards dictate that valuation models should be consistently applied to property data that are correct, complete, and up-to-date. However, assessor records commonly contain errors relating to a property's age, total square footage, net leasable area, number of apartments, unit mix, and facility amenities. An error in one of these fundamental property characteristics can significantly increase a property's overall assessment.

When arguing errors in specific property data, apartment owners should be prepared to share a current rent roll with their assessor in order to document the property's square footage, net leasable area, number of units, and unit mix. It may also be helpful to provide the assessor with copies of the property's most recent marketing materials, which show the project's various floor plans and amenities. Finally, pointing out land-size discrepancies or external nuisances such as traffic or airport noise can be helpful in arguing for lower values.

Income Approach
Assessors typically use the income approach in valuing apartments. Mass appraisal application of the income approach begins with collecting and processing income and expense data gathered from the marketplace. Appraisers then compute normal or typical gross incomes, vacancy rates, and expense ratios to arrive at a net income that is capitalized using a market-driven cap rate. This approach is often problematic because it fails to take into account a property's unique economic performance in a dynamic market.

Perhaps the best defense against excessive appraisals is to attack an assessor's mass appraisal income pro forma. Apartment owners should distinguish their property's rental rates and expense ratios from market data by providing current and prior-year operating statements if the numbers support a value reduction. Assessors often overestimate rent and underestimate expenses.

Owners should also provide occupancy reports to portray the property's occupancy trends, compare the property's occupancy level with market comparables, and outline any concessions and allowances the owner provides renters to maintain occupancy. The standardized vacancy and collection loss factor used in a mass appraisal income approach rarely captures the true physical and economic occupancy of a project.

Finally, owners should refute cap rates derived from sales of properties that aren't comparable to the subject.

Mass appraisal is a necessary evil that apartment owners should guard against. Knowing how assessors apply the procedure will help taxpayers in their continued fight to reduce property taxes.