Tax issues

Analyzing Local Tax Laws Can Save Property Owners Money

Property taxes are a major expense for commercial property owners -- often second only to financing costs. Yet many owners resign themselves to rising property tax expenses, accepting their annual assessments as a cost of doing business.

Because property values rise and fall over time, owners and commercial real estate professionals should understand that actively managing their tax assessments could bring significant savings and improved financial performance.

Why So High? Property tax assessments may be high for a variety of reasons, including reliance on mass appraisal techniques that ignore individual properties` particular circumstances; failure to consider depreciation and other factors affecting value; improper classification of property; double taxation resulting from assets taxed as both real and personal property; failure to properly consider a property`s net operating income; and inequities in tax assessments for comparable properties in the same tax district.

In the current economic environment, local governments are under increased pressure to balance budgets, and property taxes are a major funding source. At the same time, economic forces are driving down market values of the very properties that generate tax revenue. While many jurisdictions are quick to increase assessments in a rising market, they are less likely to decrease them in downturns.

Political pressure often makes it difficult to raise tax rates to maintain local revenues, so the burden of maintaining the property tax revenue base often falls to property owners in the form of inflated assessments.

Tax Reduction Strategies Property owners can challenge assessments each year and should be aware of the annual appeal deadlines and the required procedures of the jurisdiction in which their properties are located.

In general, the key to reducing property taxes is to ensure that the assessments reflect the current property value.

Several types of changes may provide a sound basis to challenge -- and potentially reduce -- assessments.

Market Value Fluctuations. Assessments often are based on comparable properties` sales prices. However, real estate values are constantly changing, and property tax assessments typically lag behind current market conditions.

Business Strategy Changes. A company`s business strategies heavily influence corporate real estate values. Changes in asset mix and operational needs significantly may alter the value associated with individual properties.

Functional and Economic Obsolescence. A property`s income-producing potential is a primary determinant of its value. Technological advances and changes in the economic and competitive environment quickly can erode the property`s income-producing potential.

Environmental Issues. The presence of environmental contaminants or the imposition of new environmental restrictions may reduce the value of certain properties.

Actively managing a company`s property tax expenses typically includes the following steps.

A preliminary review of a company`s real and personal property tax position is a good starting point. Comparing assessment trends over time, reviewing assessments with those of comparable properties, and identifying properties with subpar financial performance can help to identify potential valuation issues and appeal opportunities.

If an initial review indicates that a more in-depth analysis is warranted, a comprehensive property tax study may include: verifying the information and assumptions on which current assessments are based; identifying functional and economic obsolescence; reclassifying and reappraising real and personal property; analyzing market conditions and inequities in assessments for comparable properties; and identifying potential exemptions, credits, and abatements.

Several types of major changes to a property can affect property taxes. Tax assessments for new construction and major renovations generally are based on cost, rather than the final structure`s value. Many jurisdictions issue progress or partial assessments during construction. Evaluating whether these assessments are accurate, or even warranted, and whether the final assessment is equitable is important.

In addition, acquisitions often trigger a reassessment. Purchase documents and any purchase price allocations should be reviewed to ensure that they appropriately allocate the purchase price to the properties acquired as well as to any intangible assets.

Many municipalities offer special property tax reductions to encourage economic development. Some cities also offer credits and abatements for installation of pollution control equipment. Companies that are undertaking environmental cleanup also may qualify for reduced tax assessments, particularly if cleanup costs can be quantified.

Personal Property Taxes In addition to real estate taxes, many states levy taxes on personal property. Generally real property includes land and land improvements, such as buildings. Business personal property, which often is part of a property`s tax assessment, consists of tangible assets (other than real property) employed in a business.

If an item permanently is affixed to a building it generally is considered real estate, whereas an item that could be removed and used in a different location generally is considered business personal property. Taxes on these assets are based on the company`s list of its personal assets, to which local depreciation tables are applied.

Confusion and errors easily can arise because statutes and local practices vary considerably. Many potentially costly errors could occur, ranging from incorrect classification to inaccurate reporting. The result often is overassessment. To avoid this, property owners should gain in-depth knowledge of the local property tax rules as well as familiarity with the property in question.

In addition, depreciation tables generally do not consider technological obsolescence or an industry`s economics. A current valuation could remedy such problems.

In general, fixed-asset systems are designed to meet book accounting or federal income tax requirements, but may be ill-suited to property tax reporting. Failure to adjust fixed-asset records to reflect local property tax rules typically results in overreporting for property tax purposes. For instance, a cost segregation study performed for federal income tax purposes will identify items such as wiring, lighting, and flooring that qualify as personal property subject to accelerated depreciation for federal income tax purposes, but for property tax purposes such items typically are assessed as real estate and should not be reported as personal property.

Deane Eastwood

Deane Eastwood is a partner in the Baltimore office of Ernsty & Young. He specializes in state and local taxes. Contact him at (410) 783-3752 or deane.eastwood@ey.com.

Recommended

A Charitable Remainder Trust Case Study

Winter 2022

Selling a rental property allowed one CRE professional to establish cash flow via a charitable remainder trust. 

Read More

A Future for Infrastructure

Spring 2021

With potential bipartisan support for infrastructure, could 2021 be the year for a breakthrough in Washington, D.C.?

Read More

3 Tax-Specific Paths to Liquidity for Real Estate Investors

Winter 2021

The 2020 CARES Act, passed amid the initial outbreak of COVID-19, opens doors for real estate investors.

Read More

Forming a Tax Plan

March.April.19

The real estate industry generally fares well under the 2017 Tax Cuts and Jobs Act, but many new provisions heighten the importance of advance tax planning for real estate investors.

Read More