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.

Where the value of commercial properties has failed to keep pace with local governments’ revenue needs, real estate assessors have pursued unconventional arguments and valuation methods to protect and grow the property tax base. Among those arguments and methods, assessors increasingly contend that manufacturing and other commercial properties are “special-purpose properties,” and therefore the property tax assessments on these assets should exceed the value that would result from the use of traditional market data.

While special-purpose properties certainly exist, these assessors’ arguments typically fail in three ways. First, they erroneously confuse limited-market property with special-purpose property. Second, they refuse to consider available market evidence that, even if imperfect, provides information about the value of the property. Third, even when a property is a special-purpose property, assessors often value the wrong interest, valuing more than the fee simple real estate, for example.

Wrong definition, incorrect assessments

The Dictionary of Real Estate Appraisal defines special-purpose property as "[a] limited-market property with a unique physical design, special construction materials, or a layout that restricts its utility to the use for which it was built; also called special-design property.” Thus, special-purpose property is both a limited-market property and a property having a unique physical design, special construction materials or a layout that restricts it to the use for which it was built. By definition, special-purpose properties are a subset of limited-market properties; they are not synonymous.

RELATED

• Big-Box Retail Offers Property Tax Lessons to Industrial Owners
• An Industrial Real Estate Revolution

A subset, not the same set

In general, special-purpose properties are a subset of limited-market properties, which are a small subset of commercial properties.

Appraisers often identify certain categories of property as special purpose, such as churches, schools, railroad stations and sports arenas. But such properties, in addition to being limited-market properties, also reflect specific evidence of unique physical design, highly restricted use and/or special construction materials.

The facts of a New Jersey case illuminate the difference between properties with special features and special-purpose properties. In Ford Motor Co. vs. Township of Edison, the New Jersey Supreme Court in 1992 concluded that an automotive manufacturing plant was a general-purpose property, even though it was constructed with heavy steel framing, paint booths, baking ovens, massive boilers, terrazzo amenities, and electrical, steam and plumbing infrastructure that exceeded normal industrial requirements. Although the property was a limited-market property, the court noted that “[a] property does not qualify as special-purpose where it possesses certain features which, while rendering the property suitable to the owner’s use, are not truly unique.”

Importantly, whether a property is special-purpose is a fact-specific inquiry, and courts rightly reject attempts to classify properties as special-purpose in the absence of evidence that the property is special-purpose. Other cases reinforcing this concept include a 2015 decision in Certain Teed Corp. vs. County of Scott, in which a Minnesota tax court rejected the contention that a shingle factory was a special-purpose property; and TD Bank vs. City of Hackensack, a 2015 case in which a New Jersey tax court rejected an argument that a bank branch is a special-purpose property.

Refusal to consider market data may lead to higher assessments

Assessors typically argue that special-purpose properties may only be valued using the cost approach; that market comparable sales may not be used to value special-purpose property, and/or that the value of the special-purpose property is so intimately tied to the property’s owner or user that the assessor must use income from business operations (as opposed to rents) to value the property.

These arguments share a flawed premise that, due to the property’s unique nature, there is simply no market data available to value the property. These arguments often fail because they conflict with real world evidence.

For example, while it may be true in a given case that there are few or no comparable market transactions for a special-purpose property, this is not an appraisal rule or point of law. That is why the Minnesota Supreme Court in 2007 reversed the decision of a tax court that had refused to consider available sales data based on the classification of the property as special-purpose. In that case, Southern Minnesota Beet Sugar Coop vs. County of Renville, the Court acknowledged that if market transactions exist and shed light on the value of a special-purpose property, it should be considered even if adjustments must be made to account for differences between the comps and the subject property.

Just as it is wrong to refuse categorically to consider market transactions when valuing special-purpose property, it is inappropriate to consider taxpayer-specific income data reflecting more than the value of the real property. For example, special-purpose manufacturing properties are seldom rented in the market. Attempting to value the real estate based on non-rental income from the manufacturing operations would produce a highly misleading estimate of value, since such income is derived from non-real estate elements such as intangibles and personal property. Examples of intangibles include an in-place work force, intellectual property and goodwill; personal property includes items such as manufacturing machinery and equipment.

Given the tenuous link between manufacturing income or business income and the value of a special-purpose property in which the manufacturing occurs, taxpayers can—and should—object to the assessor’s use of such income information to value the real property, even if it is a special purpose property.

When assessors increase assessments or defend excessive assessments by claiming that the property is special-purpose, taxpayers should request the evidence on which the classification and the valuation are based. In many cases, taxpayers will find that such assessments lack support, conflict with generally accepted appraisal practices, and should be appealed.

David Suess is a Partner in the Indianapolis law firm of Faegre Baker Daniels LLP, the Indiana member of the American Property Tax Counsel. He can be reached at david.suess@faegrebd.com.

Utah property owners should be aware of tax laws that may even apply to tax-exempt properties.

When a business owner leases property that is exempt from property tax and then uses that property in connection with a for profit business, local taxing entities may have authority to tax the property's user. Whether and to what extent that tax applies will vary by state, but in some states, including Utah, the property user's tax burden can be significant.

Under Utah law, the assessing authority may impose a privilege tax in "the same amount that the ad valorem property tax would be if the possessor or user were the owner of the property," according to the state's tax code. But because Utah's privilege tax is an all-or-nothing tax, local authorities cannot impose the tax unless the user has exclusive possession of the exempt property.

In 2012, the Utah Supreme Court had its first opportunity to determine what constitutes exclusive possession. In Alliant Techsystems Inc. vs. Salt Lake County Board of Equalization, the court identified a three-part test for determining exclusive possession and then remanded the case back to the district court to apply the test.

In April of this year, the Utah Court of Appeals upheld the district court's decision that the user of the exempt property did not have exclusive possession and could not be assessed a privilege tax for its for-profit use of that property. Details of the case, then, may provide important insight for companies in similar circumstances.

Control Issues

Alliant Techsystems Inc., the taxpayer in these appeals, is a for-profit aerospace and defense products corporation that operates on its own property, as well as on the Naval Industrial Reserve Ordnance Plant, a property owned by the U.S. Navy. Alliant and the Navy entered into a facilities-use agreement that governs the company's use of the ordnance plant. In 2000 and for all subsequent years, Salt Lake County imposed a privilege tax on Alliant for its use of the ordnance plant. The county based the amount of the tax on the full value of the exempt property.

Alliant challenged the county's assessment of the privilege tax on the basis that it did not have exclusive possession of the property due to the control retained by the Navy. The Salt Lake County Board of Equalization, the Utah State Tax Commission and then the district court concluded that Alliant had exclusive possession of the ordnance plant because no other party had an agreement with the Navy to use the property. ·

Alliant appealed to the Utah Supreme Court, which interpreted exclusive possession to mean exclusive as against all parties, including the property owner.

Utah's Test

The Utah Supreme Court's three-part test for exclusive possession requires that the user or possessor have (1) the general power to admit or exclude others, including the property owner, from any present occupation of the property; (2) the authority to make broad use of the property, with only narrow exceptions; and (3) possession and control of a definite space for a definite time.

Alliant relied on several points to demonstrate that it lacked exclusive possession of the Navy's ordnance plant, due to the control retained by the Navy:  For one, the Navy had erected a fence surrounding the property, and posted signs stating that the property belonged to the United States government. Additionally, the parties' operating agreement stated that unauthorized use of the property could result in fines, imprisonment or both.

Alliant also pointed out that the facilities-use agreement permitted the Navy to terminate Alliant's right to use the property at any time and for any reason, and at any time to change or terminate the list of facilities that the company may use. The Navy maintained onsite representatives to manage some of the ordnance plant's operations.

Finally, Alliant lacked authority to exclude the Navy or anyone authorized by the Navy from the property; neither could the company use the property for non-Navy purposes without permission from the Navy.

The county didn't dispute these points, and the district court held that Alliant lacked exclusive possession of the ordnance plant property and was exempt from the privilege tax. The county appealed the decision and the Utah Court of Appeals upheld the district court's decision.

Whether a state can tax the business use of exempt property by a lessor will depend on how each state's tax laws are written. If the tax is based on the full value of the property, and the lessor can demonstrate that the property owner maintains control of the property, the user may challenge the tax as violating the Supremacy Clause of the U.S. Constitution, which establishes the supremacy of federal law (and federally established tax exemptions) over state and local laws. Alliant raised that challenge in its appeals, put the court declined to address the constitutional challenge because its interpretation of the statute fully resolved the matter.

Stephen P. Young is a partner in the law firm of Holland & Hart, the Montana, New Mexico, Utah and Wyoming member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at spyoung@hollandhart.com.

A firm understanding of how assessors apply market data locally comes in handy for savvy owners.

The real estate market is flourishing, as articles in Heartland Real Estate Business seem to confirm. Recent headlines such as “General Contractors are off to a Running Start,” and “Speculative Industrial Construction is Making a Come Back in St. Louis Market,” certainly are encouraging to readers.

But investors must remain diligent in keeping their assessed property values in check, or risk paying for their complacency later.

By monitoring assessments and challenging them when necessary, taxpayers can maximize profit and stay competitive when the cycle inevitably reaches its peak and the market begins to slide.

To minimize taxes, every taxpayer should understand the property tax system. That requires a grasp of local market dynamics and how assessors apply market data in establishing assessments.

Real estate taxes are merely a function of the tax rate multiplied by the assessment. The assessment is the measure that, if applied equally, and based solely upon bare real estate, that measure will yield uniform taxation for you.

Assessments tend to follow Newton’s law of inertia. Sales often set assessments in motion, but that doesn’t mean that sale prices always lead to assessments.

Price Versus Value

Too often, assessors confuse price with taxable value. Assessed or taxable value should be based on real estate alone. Sale prices, on the other hand, often reflect other factors that greatly affect the sale.

For instance, the business acumen of tenants and property managers often influence commercial property prices.

The lodging industry has an abundance of business and personal property value that is often difficult to distinguish from real estate value.

Hotel buyers are often purchasing in-place contracts, a workforce, personal property, reservation systems, the reputation of food and beverage providers, and other intangible items. As a result, the business value of a hotel tends to fluctuate more rapidly than the actual value of the “bricks and sticks.”

Because these intangible elements are factored into the sale, an assessment that is later based on the sale price will reflect more than the real estate value, unless the taxpayer takes the right steps to prevent that from happening.

What to look for

It is possible to strip away non-taxable components and turn a sale into a useful indicator of market value. An assessor can rely on a properly adjusted sale in the assessment of the subject property, and when valuing comparable properties. But what is the proper method of adjustment?

Excluding intangibles from taxable value can be an elusive goal. Investors often place tremendous value on the credit-worthiness of tenants, length of lease terms and other non-real-estate items. Those components depend on the occupant’s business rather than upon the location or condition of property improvements.

For assessment purposes, sales must be adjusted to reflect what the price would be if the tenant were a typical market tenant, paying market rent under current market lease terms.

State nuances

Taxpayers should consider not only the sale itself when evaluating for assessment, but also the particular state’s laws concerning assessments. For instance, Ohio recently amended its statutes to preserve it in assessments. Prior to the amendment, an assessor “must” have considered a recent sale price to be the new assessment of the property, regardless of any non-real-estate factors that might have affected the sale price.

Under the amended statute, assessors “may” use the sale, assuming that the sale reflects the “fee simple as if unencumbered value.” Thus, Ohio now takes a more nuanced approach, assessing properties based on market rents rather than in-place contract rents, along with the intention that assessors use market occupancy and market creditworthiness in assessments.

Taxpayers in other states have challenged assessment statutes to achieve more equal and taxation. Courts in Michigan addressed the concept of build-to-suit leases and contract rents, which the initial tenant pays in part to repay the developer’s costs, making contract rents incomparable with market rents.

Michigan now requires assessors to utilize market rents and other market indices to determine market value. Likewise, courts in Kansas and Wisconsin have established case law recently that requires more equal and assessment practices.

While there may be similarities between some states regarding their assessment laws, and a general trend of states moving toward more assessment, all states apply their laws differently.

Taxpayers must give due care to their state’s distinct approach.

J. Kieran Jennings is a partner in the law firm of Siegel Jennings Co. LPA, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at kjennings@siegeltax.com.