Reporting the sales price on a transaction for a real estate excise tax affidavit or refund petition can be tricky in the State of Washington, depending which side of the coin you’re on.

Seattle's hot real estate market presents two special tax-saving opportunities – or, for the unwary, two tax traps – involving Washington State's real estate excise tax.

The first arises when above-market rents in place at a property contribute to its selling price. The second occurs when the sale of a property experiences high vacancy. In both scenarios, some buyers and sellers report prices that are higher than they should be for the real estate excise tax. At nearly 1.8 percent of the property's sale price, real estate excise tax is a sizable trans-action cost that deserves attention.

Skewed By High Rents
With above-market rents, a portion of the sale price may reflect the value of contracts and business efforts. The tax only applies to the consideration paid for real estate, so the consideration paid for above-market contracts should be separated out as nontax-able.

Although we believe Washington law is clear on this, the Department of Revenue has been struggling to determine its position. The department recently agreed taxable value excludes the portion of the purchase price attributable to above-market rents, but then it changed its position.

Since these vacillations occur in the context of individual taxpayer cases, other taxpayers do not necessarily know what the department's position is at any given time. The department has not published any rules or guidance specific to this scenario.

Impaired By Vacancy
In the scenario involving the sale of a property with high vacancy, the buyer and seller frequently agree on a price as though occupancy were full and then deduct an amount for the vacancy shortfall. The deduction reflects the costs to lease the remaining space, and also the entrepreneurial profit the buyer requires for undertaking the risk and work required to achieve full occupancy.

Some parties to a transaction mistakenly report the stabilized value instead of the amount actually paid for the property. The only price they should report for tax purposes is the sum after deducting for vacancy, as that represents the actual amount paid.

Both parties have an incentive to ascertain and report the correct price on the real estate excise tax affidavit. Though the parties can negotiate who pays the tax, the seller is responsible for its payment by law. And yet, the Department of Revenue can enforce payment by placing a lien against the property, making the buyer indirectly liable.

Both buyer and seller sign the affidavit reporting the sales price, under penalty of perjury. Buyers may feel the ongoing effect of the reported price in the form of property taxes, since county assessors pay attention to the affidavits in determining property tax values. With this in mind, both parties should care about correctly reporting the transaction.

Buyers and sellers in either scenario can put themselves in a favorable tax position by presenting the information about the transaction carefully, whether in the affidavit or in a refund petition to the Department of Revenue. Note that a refund petition, if applicable, must be filed within four years of the transaction date.

Information about the transaction should be presented to the taxing authorities in a clear manner to establish the correct facts and legal analysis. In the first scenario, a detailed explanation of the facts ideally includes an appraisal that excludes the price paid for the value of the above- market leases in place, as opposed to the real property.

In reviewing the transaction, the Department of Revenue should presume the price paid is taxable, but the taxpayer can rebut that position. When the transaction price reflects more than the price for real estate alone, the department often next turns to the property's assessed value instead.

The taxpayer can argue that, by law, an appraisal as of the sale date trumps the assessed value as evidence of the taxable amount. For this reason, an appraisal is important for the above-market rent scenario.

In the high-vacancy scenario, however, the presumption applies that the price paid is taxable, and no appraisal should be needed. Therefore, the parties should report the actual price paid after accounting for the vacancy shortfall.

Recent experience indicates the Department of Revenue may choose to challenge an affidavit or deny a refund claim if it takes the position that the portion of the price attributable to above-market rent is untaxable. That does not mean the department is right, however, and its vacillations suggest its directors feel uncertain about their position. Taxpayers with strong facts should pursue the issue and work diligently to make a strong case that will help the department get to the right result.

Whether a sale involves the added value of contracts or a deduction for high vacancy, seeking professional advice about how to best report the transaction on the real estate excise tax affidavit, or in a refund petition, can turn the sale into a significant tax opportunity.

Norman J. Bruns and Michelle DeLappe are attorneys in the Seattle office of Garvey Schubert Barer, where they specialize in state and local tax. Bruns is the Idaho and Washington representative of American Property Tax Counsel, the national affiliation of property tax attorneys. Bruns can be reached at nbruns@gsblaw.com. DeLappe can be reached at mdelappe@gsblaw.com.

The music continued to play in 2015 for the white-hot multifamily market, as many investors saw rents and occupancies climb higher and cap rates fall. Sales of apartment projects still under construction remain commonplace. Record-high sales prices seem to be the norm.

Accompanying the high prices, however, are rapidly increasing property tax valuations. Multifamily investors should be prepared for such increases, and be ready to combat overassessments. All multifamily investors should also be aware of the myriad property tax issues associated with the development, purchase or sale of their particular project.

The amount of attention property owners pay to property taxes often depends on the investor's specific situation. For instance, property taxes may indeed be the most pressing concern for a long-term owner of an apartment complex who receives a tax notice 50 percent higher than the previous year's bill, based on a lofty sales price paid for a new project down the road. Not only does this investor have to compete for tenants against a new development with better amenities; he or she now has to pay more in taxes because of that same development, effectively slashing the property's net operating income.

On the other hand, a developer might be preoccupied with his own, more immediate concerns, such as site selection, construction schedules and financing. Even so, the developer should be mindful of important property tax considerations: Are there property tax incentives available, such as affordable-housing exemptions, brownfield abatements and many others? What is the valuation date for assessment purposes? How do assessors assess the value of construction in progress? Will a change in use trigger any roll-back taxes, or increase the tax rate?

Careful property tax planning is of vital importance to purchasers of multifamily properties. A purchaser of a newly constructed apartment complex must determine how an assessor will value the property after closing. Will the assessor base the value on construction costs, sales of comparable properties, income information or a combination thereof?

Unfortunately, some investors wrongly assume that property tax values will remain unchanged following a transaction. Although a sale will not necessarily result in a new tax value, tax assessors are increasingly trying to catch up to sales prices that exceed current assessed market values.

Underestimating property taxes at the time of the purchase can significantly reduce the investor's actual return. For that reason, a purchaser should carefully scrutinize any tax estimate based on an assessed value that is lower than the purchase price.

Purchasers of low-income housing tax credit (LIHTC) properties should consult local counsel to confirm whether the jurisdiction allows assessors to consider rent restrictions and tax credits in determining fair market value. In some jurisdictions, local tax laws may compel the assessor to value an LIHTC property much higher than the actual sales price.

In states that require the deed to show the purchase price, assessors frequently rely upon these deed amounts in determining fair market values. The declared transaction value on the deed too often includes consideration not attributable to the real property, such as value for personal property or intangibles, although assessors rarely take this into account. Similarly, assessors may not look behind a sale to consider factors that distinguish the acquisition from a market transa<.1:ion, such as an allocated purchase price as part of a portfolio sale.

As the multifamily market continues to sizzle, lower rates of return diminish the margin for error when estimating property taxes. Investors must recognize the importance of appropriate property tax planning, or risk an unpleasant surprise at tax time that could jeopardize their property's cash flow.

By consulting knowledgeable local professionals, investors can equip themselves to make better-informed decisions when estimating taxes. A seasoned tax expert can review tax notices for accuracy and fairness, and navigate any local rules and deadlines to challenge unfairly high assessments.

  Aaron D. Vansant is a partner in the law firm of DonovanFingar LLC, the Alabama member of American Property Tax Counsel (APTC) the national affiliation of property tax attorneys. He can be reached at adv@donovanfingar.com.

There was a time when closing a real estate sale cost the seller a few hundred dollars for transfer tax stamps on the transfer deed, but those days are long gone.  Nowadays, transfer tax can be a major consideration in structuring and funding a property transaction.  And the requirements for complying with, or being excluded from, transfer taxes have multiplied.

In some markets, transfer tax can exceed the property tax burden in the first few years after an acquisition.  For example, in San Francisco the transfer tax on property transactions valued at more than $10 million is 2.5 percent of the sales price.

Historically, transfer taxes were only collected when the county recorder’s office recorded a deed.  If a transfer occurred through the acquisition of a legal entity that owned the property, and that entity continued to exist without requiring a transfer deed, then no transfer tax was owed.

Today, however, many real estate transactions occur through the buying or selling of ownership interests in legal entities which hold title to real property, and which continue to exist and hold property after the transaction has concluded.  Technically, there is an indirect change in ownership because the legal entity is now owned by a different entity or owner, even though the title for the real estate remains unchanged.

The proliferation of these indirect property transfers has spurred tax authorities to enact laws that assess transfer taxes on indirect sales.  The deed-recording process cannot capture indirect sales, so counties and cities now require buyers and/or sellers to report such transfers through other means.

The most common way of tracking indirect transfers is to align transfer tax reporting with the property tax system.  In California, for example, taxpayers must report legal entity transfers to the state Board of Equalization, which in turn reports the transfers to county assessors.  Counties and cities which collect transfer taxes on indirect sales can now access assessor databases to learn about indirect transfers in their jurisdictions.

Most transfer tax laws contain numerous exclusions.  For example, if there is a mortgage against a property, the amount financed is excluded from the purchase price when calculating the transfer tax.  Similarly, transfers of property between entities which have the same ownership percentages are excluded from transfer taxes.  A third example is the exclusion from transfer tax for marital dissolutions.

In recent years, however, tax authorities have repealed some exclusions from transfer tax. Some jurisdictions have deleted the mortgage deduction.  Likewise, gifts and transfers upon death, and transfers to non-profit entities, which were once generally excluded, are now subject to transfer tax.

The declining number of exclusions restricts a market participant’s ability to structure transactions to be exempt from transfer tax.  That task has grown only more difficult as variations in tax rules have increased between jurisdictions at the local level.

The transfer tax has traditionally been and continues to be a local tax.  Consequently, individual counties and cities determine what elements to include or not include in their transfer tax ordinances.  Transfer taxes are an attractive way for local governments to raise revenue, particularly when other sources of tax income are limited.

In California, most counties and cities operate under the traditional transfer tax laws that the state Legislature established almost 50 years ago.  But more than a dozen counties and cities have modified the transfer tax law enacted by the Legislature.  The courts have approved such changes under the home rule doctrine, which allows communities to govern themselves with laws that don’t conflict with state or federal law.

These modifications have two primary goals: The first is to impose transfer tax on indirect transfers of real property caused by changes in the ownership of legal entities.  The second goal is to repeal the exclusions that existed in the original transfer tax laws.  In addition, the modifications have often added penalties for failure to pay transfer taxes.

California, like most states, has dozens of counties and hundreds of cities, which means that buyers and sellers of real property must familiarize themselves with the specific provisions in local transfer tax ordinances.

Transfer tax compliance used to be as simple as checking a box.  But high transfer tax rates, the prevalence of indirect property sales and rising property values have increased the significance and complexity of transfer taxes in property transactions.  Awareness of tax rates, available exclusions from the transfer tax and compliance and reporting requirements is essential to maximize property value and avoiding reporting pitfalls.

Cris K. O'Neall is a shareholder at the law firm Greenberg Traurig, LLP and focuses his practice on ad valorem property tax assessment counseling and litigation.  The firm is the California member of the American Property Tax Counsel, the national affiliation of property tax attorneys.  He can be reached at oneallc@gtlaw.com.

If the compelling evidence is on your side, the record shows you have a fighting chance.

The best time to consider how an appellate court might view a property tax appeal is not after a trial court delivers an unwelcome decision.  Rather, as the taxpayer carefully plans the evidence to be submitted at trial, it is worthwhile to consider how the evidence will look to appellate judges.

The handling of tax cases in appellate courts receives comparatively little attention.  Yet an appellate court may well make the final decision in a property tax appeal.  That appellate court may even be a state’s highest court, typically (though not always) the state’s supreme court.

Based on the attention given to appellate court strategies in tax literature, the handling of appeals is a neglected orphan in the property tax process.  Innumerable property tax articles address how assessors mass appraisal methods can overstate a property’s market value.

Writers cover pitfalls of the typical cost and sales comparisons and income approaches to value, or detail valuation peculiarities by property type.  Little is written about the key issue that can help tax-payers prevail in the appellate courts.

The Record Rules

Everyone has heard that the three points of consequence for real property are location, location, location.  For a property tax appeal in an appellate court, those three points of consequence are the record, the record and the record.

Whether the taxpayer is the appellant or is responding to an appeal, the best chance of prevailing derives from a record filled with compelling evidence that covers the big-picture points, as well as all of the finer ones.

Some recent decisions confirm these points and show some of the opportunities and challenges that property tax appeals in appellate courts can entail.  In each case the appellate court found that the record showed the tribunal had adopted a wrong principle or made a decision not supported by competent and substantial evidence.

In one Midwestern case, the question at issue was whether the taxpayer had mistakenly reported personal property as taxable in a particular jurisdiction, even though the personal property was not only in other cities, but also in a different state.

At trial, counsel had the taxpayer testify in painstaking detail about the property and its location, including unusual costs the taxpayer incurred to maintain the property.  Notwithstanding this evidence, the tribunal held that the taxpayer had failed to satisfy its burden of proof.

At oral argument in the court of appeals, however, the taxpayer’s counsel was able to read compelling portions of the transcript to show that the trial judge had erred badly.

Sometimes judges cannot be swayed, no matter what is said at oral argument, but in this case the passages quoted grabbed the attention of all three appellate court judges, who seemed to fully understand the injustice that had occurred.  The resulting decision gave the taxpayer a complete victory.

Great Valuation Records

A second case involved a retail property in the Midwest that was almost 80 percent vacant on each of two valuation dates.  The initial tax tribunal decision adopted the appropriate methodology by using the income approach to first value the property at a stabilized occupancy of 85 percent, which the judge determined was the stabilized rate.  The judge then deducted the lost rent and costs involved over the time needed for the property to reach stabilized occupancy level.

Unfortunately, the tribunal’s decision included three technical flaws:

It deducted only a portion of the stabilization costs; it understated the area needed to be leased in order to achieve stabilization; and it included market rent that was inappropriately increased in the second tax year calculation because a gross lease was misconstrued as a net lease.

The record, including both the testimony of the taxpayer’s witnesses as well as a carefully documented appraisal, enabled the appellate court to see that the initial decision erred on all three points.  The taxpayer was fortunate that the three-judge panel deciding the appeal was willing to carefully analyze such technical valuation issues, rather than defer to a tax tribunal judge.  Yet this successful outcome hinged on compelling recorded evidence.

In a third and similar Midwestern case, the appraiser had initially valued a retail property as stabilized and then deducted stabilization costs.  Most of those costs were to cure the property’s extreme deferred maintenance, with a small amount relating to the leasing of vacant space to achieve stabilized occupancy.

The tribunal decision erroneously adopted the interim value before applying the stabilization deductions, With a record very much like the first case, the appeals court recognized that the cost of curing the deferred maintenance had to be accounted for, yet inexplicably failed to order the deduction of the modest costs related to the property achieving stabilized occupancy.

The taxpayer’s counsel made excellent lemonade from this decision by pointing out to the government’s counsel that, undeniably, the decision was logically inconsistent, because if the costs to cure deferred maintenance had to be deducted, then the same was true of the costs to cure the excessive vacancy.

Additionally, the taxpayer’s counsel argued that given the costs of further appeals and the likelihood that the taxpayer would ultimately prevail, a sensible solution would be for the government to agree to the value with the deferred maintenance costs de-ducted.  In fact, the government ultimately did agree and settled with the taxpayer on that basis.

While this case provided the taxpayer with an excellent result, it shows that a compelling record is a necessary – but not always sufficient – condition to prevail.

Stewart Mandell is a Partner and Tax Appeals Practice Group Leader, in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan member of American Property Tax Counsel (APTC). He can be reached at slmandell@honigman.com.

Owners Must Examine The Tax Consequences Of Making Capital Improvements Before Breaking Ground

For nearly 40 years, states have attempted to protect property owners from rapidly escalating property tax bills by limiting increases in the taxable value of real estate.  Often referred to as “caps,” these limitations are myriad and complicated, but share a tendency to distort the market for developers of new space and for property owners seeking to improve existing commercial properties.

How so?  Laws are state-specific, but taxpayers purchasing or improving real estate may lose the benefit of the cap on their property’s value, and incur a substantial tax increase on top of the acquisition or improvement cost.  In other words, caps discourage property owners from improving their properties, while owners who know how caps apply can access tremendous savings.

Caps in Action

Caps apply by limiting increases in taxable value for properties subject to reassessment that would otherwise rise to reflect the market.  For example:  California’s Proposition 13 generally limits annual valuation increases to 2 percent, even if the property’s market value is rising at a faster rate.  Common triggers for reassessment are an ownership change, countywide reassessment and improvements to the property.

Some states exempt a fixed percentage of any increased assessed value following an ownership change.  Ownership changes can include not only title transfers but also internal transfers of interests in the entity that owns the property.  To access this exemption, the taxpayer may need to take some timely action, such as filing a claim or meeting other state requirements.  Miss the deadline, and the exemption disappears.

Consequences of an oversight can be dramatic.  For example, an apartment complex previously assessed, capped or otherwise, at $20 million sells for $30 million.  Rather than incur taxes reflecting the full $10 million increase in value included in the sale price, the buyer qualifies for a 25 percent tax exemption, or $7.5 million.  Yet, failure to file a timely exemption application could result in taxation of that otherwise exempt $7.5 million of the total value.

Many jurisdictions cap value increases during periodic reassessment.  Florida generally limits annual increases to 10 percent of assessed value for the prior year.  South Carolina, which theoretically reassesses every five years, limits increases to 15 percent of the property’s prior assessed value unless there has been a property improvement or a change in ownership.

Some limits disappear if there has been an ownership change.  Florida generally defines an ownership change as any sale or transfer of title or control of more than 50 percent of the entity that previously owned the property.  South Carolina has adopted a much more complicated system of assessable transfers of interest (ATI’s).  The definition of an ATI runs for four full pages in the South Carolina Code.

Impaired by Improvements

With tax caps, taxpayers who improve their properties face even greater potential tax consequences, because states generally remove artificial caps on new construction and major renovations.  In other words, the total cost of improvements can include not only construction expenses but also a substantially heavier tax burden.  The result places an improved income-producing property at a serious disadvantage in competing with unimproved properties.

What constitutes an improved property? Florida has adopted a bright line test by examining whether the improvements increase value by at least 25 percent.  California law protects properties from reassessment so long as any work is normal maintenance or repair, or the improvement does not make the property “substantially equivalent to new.”

South Carolina is much more complicated and unclear.  The state requires assessors to include the value of new construction in valuing properties, but its statutes fail to define “improvements,” leaving interpretation to local taxing authorities.

The result is a patchwork quilt of inconsistency.  In order to circumvent South Carolina’s 15 percent cap on periodic reassessment, some counties have adopted a stepped approach to increases in value, although such a procedure is clearly unauthorized by statute.  Other counties simply add the value stated in building permits to existing assessed value in order to derive a new value, though the market would never see a sale on that basis.  Still other counties assume stabilization in valuing a new or improved income-producing property such as a hotel rather than accurately valuing the property before stabilization.  Clearly, a property owner improving a property faces a potential hidden cost in the form of increased taxes by loss of the statutory cap.

Reimplementation of tax caps on an improved income-producing property further complicates an owner’s prediction of costs.  Whatever the method of valuing the improvements, how does South Carolina’s 15 percent general cap apply to future valuations when the property value may be much greater?

If the taxing authority simply adds the cost of the increased value set forth in building permits, has the taxing authority fully captured an increase in value which, in turn, may be subject to re-imposed caps?  To state the obvious, an owner will not improve a property merely to re-cover the cost of improvements, but rather sees the potential of income gains exceeding improvement costs.

Most income-producing properties will generally require some period of time for lease up or stabilization.  Should the taxing authority be allowed to make assumptions of future income that the market would not make if the property sold prior to stabilization?  These questions have no easy answers.

Regardless of the system used for valuing new improvements, caps give a competitive advantage to owners of unimproved property in the form of lower costs.  Property owners must examine the obvious – and hidden – tax consequences of improvements to determine whether potential income from improvements justifies the costs.

Morris Ellison is a partner in the Charleston, S.C., office of the law firm Womble Carlyle Sandridge & Rice LLP. The firm is the South Carolina member of American Property Tax Counsel, the national affiliation of property tax attorneys. Morris Ellison can be reached at mellison@wcsr.com.

There was a time when closing a real estate sale cost the seller a few hundred dollars for transfer tax stamps on the transfer deed, but those days are long gone.  Nowadays, transfer tax can be a major consideration in structuring and funding a property transaction.  And the requirements for complying with, or being excluded from, transfer taxes have multiplied.

In some markets, transfer tax can exceed the property tax burden in the first few years after an acquisition.  For example, in San Francisco the transfer tax on property transactions valued at more than $10 million is 2.5 percent of the sales price.

Transfer tax scope widens

Historically, transfer taxes were only collected when the county recorder’s office recorded a deed.  If a transfer occurred through the acquisition of a legal entity that owned the property, and that entity continued to exist without requiring a transfer deed, then no transfer tax was owed.

Today, however, many real estate transactions occur through the buying or selling of ownership interests in legal entities which hold title to real property, and which continue to exist and hold property after the transaction has concluded.  Technically, there is an indirect change in ownership because the legal entity is now owned by a different entity or owner, even though the title for the real estate remains unchanged.

The proliferation of these indirect property transfers has spurred tax authorities to enact laws that assess transfer taxes on indirect sales.  The deed-recording process cannot capture indirect sales, so counties and cities now require buyers and/or sellers to report such transfers through other means.

The most common way of tracking indirect transfers is to align transfer tax reporting with the property tax system.  In California, for example, taxpayers must report legal entity transfers to the state Board of Equalization, which in turn reports the transfers to county assessors.  Counties and cities which collect transfer taxes on indirect sales can now access assessor databases to learn about indirect transfers in their jurisdictions.

Fewer exclusions, a patchwork of requirements

Most transfer tax laws contain numerous exclusions.  For example, if there is a mortgage against a property, the amount financed is excluded from the purchase price when calculating the transfer tax.  Similarly, transfers of property between entities which have the same ownership percentages are excluded from transfer taxes.  A third example is the exclusion from transfer tax for marital dissolutions.

In recent years, however, tax authorities have repealed some exclusions from transfer tax. Some jurisdictions have deleted the mortgage deduction.  Likewise, gifts and transfers upon death, and transfers to non-profit entities, which were once generally excluded, are now subject to transfer tax.

The declining number of exclusions restricts a market participant’s ability to structure transactions to be exempt from transfer tax.  That task has grown only more difficult as variations in tax rules have increased between jurisdictions at the local level.

The transfer tax has traditionally been and continues to be a local tax.  Consequently, individual counties and cities determine what elements to include or not include in their transfer tax ordinances.  Transfer taxes are an attractive way for local governments to raise revenue, particularly when other sources of tax income are limited.

In California, most counties and cities operate under the traditional transfer tax laws that the state Legislature established almost 50 years ago.  But more than a dozen counties and cities have modified the transfer tax law enacted by the Legislature.  The courts have approved such changes under the home rule doctrine, which allows communities to govern themselves with laws that don’t conflict with state or federal law.

These modifications have two primary goals: The first is to impose transfer tax on indirect transfers of real property caused by changes in the ownership of legal entities.  The second goal is to repeal the exclusions that existed in the original transfer tax laws.  In addition, the modifications have often added penalties for failure to pay transfer taxes.

California, like most states, has dozens of counties and hundreds of cities, which means that buyers and sellers of real property must familiarize themselves with the specific provisions in local transfer tax ordinances.

Transfer tax compliance used to be as simple as checking a box.  But high transfer tax rates, the prevalence of indirect property sales and rising property values have increased the significance and complexity of transfer taxes in property transactions.  Awareness of tax rates, available exclusions from the transfer tax and compliance and reporting requirements is essential to maximize property value and avoiding reporting pitfalls.

Cris K. O'Neall is a shareholder at the law firm Greenberg Traurig, LLP and focuses his practice on ad valorem property tax assessment counseling and litigation.  The firm is the California member of the American Property Tax Counsel, the national affiliation of property tax attorneys.  He can be reached at oneallc@gtlaw.com.

Frequent reassessments benefit Pittsburgh-area property owners.

Pittsburgh-area properties are being reassessed more frequently than in the past – and that is good news for property owners.  Periodic reassessment helps to keep property assessments current with actual values and ensure that everyone pays their fair share.

Unfortunately, frequent reassessments are not the norm throughout Pennsylvania.  Pittsburgh and surrounding counties are the exception, with Allegheny County (in which Pittsburgh is located) having four reassessments in the last 15 years.  Nearby Indiana County is undergoing a reassessment now for tax year 2016, its first since 1968, and neighboring Washington County is undergoing a reassessment for tax year 2017.

Pennsylvania lacks a mandatory revaluation cycle.  A revaluation or reassessment is a thorough analysis of every property in the entire county, with the objective of bringing each property’s assessment into line with its current market value.  Revaluations are often conducted by outside firms, usually with the assistance of the local assessment office.  Occasionally, in-house assessment offices conduct reassessments.

Without a mandate to reassess, some counties go decades without a reassessment.  Rural Franklin County, for example, last reassessed in 1961.   Assessors there attempt to keep properties equalized by placing newly constructed assets on the tax rolls for what they believe the properties would have been worth in 1961.

The more time that passes, however, the more tenuous this methodology becomes.  Further, assessors are prohibited from “spot assessing,” or changing assessments on existing properties without a countywide reassessment.  Thus, as different parts of the county appreciate at different rates, the equality of assessment becomes more and more skewed.

Blair County, west of Pittsburgh, decided to undertake a reassessment for tax year 2017 after commissioning a study from the attorneys at Weiss Burkardt Kramer.  Comparing actual sales in the county to assessments, the study concluded that Blair County’s more than 50-year-old assessments do not meet the constitutional uniformity requirement.

Says attorney M.  Janet Burkardt, a partner at Weiss Burkardt Kramer: “If assessment systems are not periodically adjusted, they become regressive so that properties appreciating at a higher rate are taxed at less than their fair share, and properties appreciating at a lesser rate or those who have depreciated in value, pay more than their fair share in taxes.”

Because properties that benefit from unfairly low assessments rarely appeal those values, inequities become locked in over time.  For instance, in one county where revaluation had not occurred in decades, major office buildings were, on the whole, dramatically under-assessed.

Some under-assessed buildings paid such low taxes that they enjoyed a competitive advantage in attracting tenants.  A neighboring office building, despite paying dramatically higher taxes than its competition, had no recourse to appeal because it was also under-assessed and could not meet the test that its market value was too high.  The solution? A county-wide reassessment.

The longer a county goes between reassessments, the harder the next reassessment becomes.  First, big increases in assessments spark taxpayer outrage, tempting county leaders to push the problem off to another day.

Infrequent reassessments are also more time-consuming and expensive; reassessments in Pennsylvania usually stem from litigation, which is expensive and inefficient.  Less frequently, county leaders prompt the reassessment, as Indiana County did when it had reached the statutory cap on its tax rate.

In marked contrast, Erie County, to Pittsburgh’s north, was the first county to impose a reassessment cycle on itself.  “Our goal in reassessing is to gain uniformity and accuracy,” said Scott Maas, Erie County’s chief assessor.  “We meet with property owners informally and we welcome the opportunity to update our data and make corrections.  We want to get it right.” Maas initiated the county’s periodic reassessment cycle and oversaw the 2003 and 2013 reassessments.

Pittsburgh’s record four reassessments in 15 years followed years-long litigation in two different cases that went all the way to the Pennsylvania Supreme Court.  Ultimately, the Supreme Court ordered the reassessment.  Pittsburgh’s reassessment in 2013 sparked 100,000 appeals; for 2015, only a few thousand taxpayers appealed, demonstrating that most properties’ assessments have been resolved to the property owners’ satisfaction.  If Pittsburgh were to continue to reassess in the next three to five years, building on this fresh data and satisfactory values, the likelihood is that there would be minimal appeals year-to-year.

Frequent reassessments benefit property owners.  When the appeals process corrects errors, the data under under-lying the assessments improves and yields more accurate values in the next reassessment.  Pennsylvania law requires that reassessments be revenue-neutral, meaning that rather than local governments enjoying a windfall when assessed values increase, governments must reduce tax rates, so many property owners see a reduction in taxes when reassessments occur.

Most importantly, reassessment yields more uniform assessments.  Uniformity of assessment is required by Pennsylvania’s constitution.  When assessments are uniform, everyone pays their fair share.  Pennsylvania’s Supreme Court spoke to this in 1909: “While every tax is a burden, it is more cheerfully borne when the citizen feels that he is only required to bear his proportionate share...”

Sharon DiPaolo is a partner in the law firm of Siegel Jennings Co., L.P.A., the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. She can be reached at sdipaolo@siegeltax.com.

Assessors' incorrect use of the data inflates property taxes.

Tax assessors across the country are drawing battle lines to pit new valuation theories against accepted appraisal methodologies.

This fierce ideological assault threatens the sustainability of retail businesses weighed down by ever-increasing property taxes.

Retail landlords who desire to have their real estate valued on a fee simple basis routinely face assessors who claim that these owners want their property valued as a “dark store.” This prickly issue originally focused on how to value big-box stores for property tax purposes, but its scope has widened to affect a range of retail property types.

Dispute’s Roots Run Deep

Woolworth’s opened the first big-box store in 1962, the same year that McDonald’s introduced the golden arches and ushered in the concept of branding stores with identical interiors and exteriors.

Over the following decades, Walmart, Kmart, Target and other retailers married the big-box format with McDonald’s-style branding. Replicating the same store in many locations increased consumers’ brand recognition and reduced the owner’s cost to develop, stock open and operate new locations.

Much of today’s controversy over assessments stems from alternative financing methods that caught on with these major retailers. The two most common strategies are build-to-suit and sale-leaseback arrangements, both of which generate rent payments that exceed market rates.

A build-to-suit is a financial arrangement where the tenant’s rent is a repayment of the developer’s cost to acquire the land and build a tenant specific building. These transactions can include a variety of other non-real estate costs, such as financed inventory, personal property and/or cashback incentives.

A retailer uses sale-leaseback transactions to free up capital by selling its building and then renting it back under a long-term lease. The rent is purely a function of the amount of capital to be financed and the number of years to pay it back.

In either scenario, a landlord with one of these above-market leases in place to a high-credit tenant will often sell the lease and property to an investor. The resulting sales price is a function of the length of the lease in place and the strength of the tenant, and has nothing to do with the real estate’s fair market value. In other words, the value is no longer what the real estate is worth, but what the investor would pay to receive the income from that user.

Bad Data Proliferates

Property valuations for tax purposes are not done as single-property appraisals. In single-property appraisals, the appraiser uses data specific to a property to develop an opinion of its value. Tax assessors, on the other hand, use mass appraisals. The latter method values a universe of properties using common data.

The problem arises when non-market data taints the assessor’s common data. For instance, if the above-market rents from build-to-suits are included in the common data, the assessor will overstate the market rental rate and subsequently overstate property value under the income approach.

Concurrently, when common data includes investor acquisitions of properties with leases in place under these alternative financing methods, the sales comparison approach to value suffers from the same flawed methodology as the income approach.

The problem doesn’t stop there, as the defective data spills over into depreciation calculations used in the cost approach to valuation, and in developing capitalization rate percentages. Using bad common data will taint every commonly used valuation method and lead to an overvaluation.

Implications Outside the Box

This issue is worth watching for shopping center owners, investors and developers for two reasons. First, big-box tenants traditionally are high-credit national retailers committed to a financing-based lease on an absolute net basis. That makes them a valuable addition to a shopping center as a draw for customers, and to the investor as a guaranteed income stream.

The second reason to closely follow the assessment issue is often overlooked, but has more serious implications. What began as an anomaly in the method assessors used to value and tax big-box stores is now spreading to all retail. Assessors increasingly use incorrect, inflated, non-market data to value anchor stores, discount and department stores and strip centers, overstating valuations for tax purposes.

Most states require assessors to value commercial real estate uniformly and equally. That means that two identical buildings should have the same value.

The taxable value should not be higher if one is leased to a high-credit tenant and the other to an independent local retailer. The value of the business may be greater for one over the other, but the value of the real estate must be the same.

Uniformity and equality dissolve when real estate values fluctuate based on nothing more than the identity of the tenant. And uniformity and equality can exist only when assessors value bricks and mortar alone. That is not valuing a dark store; that is valuing the fee simple.

Linda Terrill is a partner in the Leawood, Kansas law firm of Property Tax Law Group, the Kansas and Nebraska member of American Property Tax Counsel, the national affiliation of property tax attorneys. She can be reached at lterrill@ptlg.net.

"Economic development tools are under assult in Louisiana by tax assessors"

Louisiana tax assessors have begun assessing taxes on properties that have been exempt from property tax under economic development incentive programs, undermining one of the state's essential tools for promoting job growth and commerce.

Louisiana offers a handful of enticements to attract new business and spur economic development, including the industrial property tax exemption, inventory tax credits, payments in lieu of taxes (PILOTs) and cooperative endeavor agreements (CEAs) with private companies. Each of these incentives involves reducing a private entity's property tax liability.

Article 7, Section 14 of the Louisiana Constitution authorizes the state and its political subdivisions to enter into cooperative endeavor agreements that serve a public purpose, and Section 21 of the same article provides that public lands and other public property used for public purposes are exempt from property tax. The Louisiana Supreme Court has also recognized that economic development is a public purpose.

Under a typical cooperative endeavor agreement, a political subdivision leases industrial property to a private entity for development and operation. Since a political subdivision owns the property, it is exempt from property taxes. Unfortunately, some assessing authorities have decided otherwise, and have attempted to collect property tax in connection with these assets.

In Pine Prairie Energy Center LLC vs. Soileau, in 2014, a local industrial development board issued bonds and loaned the proceeds to privately held Pine Prairie to build an underground natural gas storage facility and associated facilities and pipelines. Prior to entering into the transactions, the industrial development board, Pine Prairie, and even the local tax assessor all agreed that, as long as Pine Prairie paid the agreed-upon lease payments and payments in lieu of taxes, the property would be exempt from property taxes during the lease period.

Pine Prairie built the facility, sold it to the industrial development board and then leased the property back for operations. The assessor subsequently listed the property on the tax rolls as Pine Prairie's property. Pine Prairie paid the taxes under protest and sued for a refw1d and declaratory judgment that it did not owe property taxes on an asset owned by the industrial development board.

The assessor contended that the property was not being used for a public purpose. The Third Circuit Court of Appeal noted that actual public use was not the criteria by which public purpose was determined. Rather, public use is synonymous with public benefit, public utility or public advantage, and involves using the natural resources and advantages of a locality to extract their full development in view of the general welfare.

Considering that Pine Prairie's investment resulted in approximately $700 million in local economic value, the court held that the project was beneficial to the public and thus the property was indeed being used for a public purpose.

In Board of Commissioner of Port of New Orleans vs. City of New Orleans, the Port of New Orleans leased property to two private entities that provide warehousing, freight forwarding and intermodal transportation services at the port. As i n Pine Prairie, the assessor assessed property taxes on the private companies that leased the properties, not on the public entity that owned them. When the companies failed to pay the taxes, the assessor attempted to sell the leased properties at a public tax sale.

The assessor argued that, because the activities of the private companies did not qualify as a public purpose as they did not constitute a governmental function, a benefit to the general public or a dedication for use by the general public, the property was not being used for a public purpose. The port authority demonstrated that the companies' activities were necessary for the operation of a port facility and that they furthered its broad public mission to maintain, develop and promote commerce and traffic at the port. The Fourth Circuit Court of Appeal punted on the question in 2014, and ordered a hearing on whether the specific activities conducted by the companies served a public purpose. That case is ongoing.

Cases like these obviously erode business confidence in the reliability of tax incentives. Although Pine Prairie won its case, it had to pay some $122,000 in taxes under protest and then sue to recover its funds. And the Port of New Orleans had its property seized and offered at tax sale, and now has to prove up that traditional port activities like warehousing, freight forwarding and intermodal transportation services, which have always been necessary to the operation of a port facility, serve a public purpose. This kind of uncertainty is devastating to economic development efforts.

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. She can be reached at angela.adolph@keanmiller.com.

To Save on Property Taxes, Beware of Inaccurate Valuations

Every year, the dreaded property tax envelope hits the desk of tax managers and property owners. Despite the anxiety that accompanies this event, surprisingly few taxpayers take reasonable steps to learn whether or not their tax documents may be overstating their liability. Many property owners simply pop an antacid and write a check to cover the bill.

Property taxes are a necessary evil be-cause in most jurisdictions, they are the primary source of revenue for funding schools, social services and other government functions. That said, of course, property taxes are also a major cost item. Approaching an assessment with a healthy dose of skepticism and an eye for common errors is a good way for owners to ensure that they are paying only their fair share of the tax burden.

Assessing property for taxation starts with determining real market value. The leased fee value of the property, or the going-concern value of a business, are inappropriate criteria for assessment and should raise red flags when they appear in a property tax review.

In a review, evaluate the origins of the property assessment to determine whether the assessed amount reflects the property's real market value. For example, if state law provides that a sale or other transfer resets real market value for tax purposes, the reviewer needs to evaluate the entire transaction.

The purchase price of a fully leased commercial building will typically reflect the value of a leased fee. The sale can reflect a higher value than it would if the property were vacant because the purchaser is achieving an immediate return on investment from in-place rents. If an asset's sale price is recorded as its taxable value, without an evaluation of market rents and lease-up costs to determine real market value, the owner will be overpaying taxes.

Similarly, the purchase of real estate within a business transaction may include compensation for goodwill, an in-place work force, management and other intangible assets that are not taxable in most jurisdictions. In order to properly reflect the value of the real property, the assessor must exclude these intangibles from the sale price, as only tangible real property is taxable.

In a complex, multi-property transaction, the buyer's appraiser typically conducts a mass appraisal of the portfolio rather than analyzing each asset in depth. However, this practice may overlook issues that affect the value of individual properties.

An allocation appraisal of that nature may overvalue a property that is encumbered by governmental restrictions which limit its development potential. Likewise, a property that carries significant environmental liability can be overvalued, resulting in a tax assessment that exceeds the asset's real market value. Drilling down to the level of the individual asset prior to reporting the sale value to the assessor may help cut the tax bill significantly.

Another overlooked source of savings hinges on recognizing that construction costs do not necessarily equate with a property's real market value. Assessors like to use the cost approach to set real market value, because it is simple and relies on the property owner's documentation of costs. But what about added costs that don't affect value?

Suppose, for instance, that the design of a manufacturing facility calls for a stairway in a certain place, but because local regulations require the stairway to be farther from manufacturing activity, an inspector directs the builder to move it. The change adds $200,000 to the project's cost without adding to the facility's real market value.

Another kind of overstatement often results when an owner builds an addition. Temporary walls, electrical infrastructure and extra labor may be required in order for the occupant to keep functioning normally. These items increase the owner's out-of-pocket costs without adding to the property's real market value. Keeping track of such costs can result in significant tax savings.

Awareness of these often overlooked pitfalls offers opportunities to trim the annual property tax bill. So between the time the bill comes in and the payment goes out, it is crucial to evaluate the bases for real market value. That will go a long way toward determining whether the assessment–and the dill–are correct.

Cynthia M. Fraser is a partner at the law firm Garvey Schubert Barer where she specializes in property tax and condemnation litigation. Ms. Fraser is the Oregon representative of American Property Tax Counsel, the national affiliation of property tax attorneys. Ms. Fraser can be reached at cfraser@gsblaw.com.