Does Cost Always Equal Assessed Value?

Will Cost Always Be the Same as Assessed Value?

Key Takeaways 

• Rising construction cost trends will likely increase your business property tax bill unless you take charge of managing company property tax assessments.
• Proactively reviewing classification and exemptions can lower the business tax burden and offset future increases.
• Hire an expert to help you document all forms of market depreciation in support of a lower assessed value.
• Working the evaluation and protest process is in your company’s best interests.

When does cost equal value and when does it not? That’s a fundamental question many business leaders should be asking these days. They should also be asking themselves how to be proactive about managing their company property tax levels to improve their bottom line during a time of tightening business conditions.

Construction Cost Trends Are Likely to Impact Tax Assessments

With inflation running at the highest level we’ve seen in half a century, on top of elevated gasoline prices, interest rates and significant labor shortages, it’s getting increasingly expensive to build factories, warehouses, and other commercial property. These macroeconomic headwinds are making steel, concrete, freight, mechanical, and building components more expensive and adding to the final contractor bill.  When you report your development costs to assessing agencies, either through return filings, permitting, or other public disclosures, you’re likely to see significant increases in future tax assessments on your property that may be quite different from the actual market value of that property, much less a fair, accurate, and equitable assessable value of that property. That disconnect could profoundly impact how much property tax you pay when bills become due later this year — and for years to come.  So, how can a business leader head off these inevitable increases at the pass?

Let’s start with understanding what typically happens during a tax protest. When a property owner or their third-party property tax consultant files a value protest, the first questions an assessor or local board will ask are:

1. When did the property sell?
2. How much was paid?
3. How much did the property cost to build?

If the property was recently constructed and/or if a portion of the property was recently constructed, a local assessor is likely to consider that cost to be a primary means of measuring assessed value.  If the property sold recently for a price falling within the range of comparable sale prices within the county, then that is a primary consideration of assessment as well.

However, there’s a high likelihood that a portion of the property owner’s recent construction costs will not be recovered with a subsequent sale price, or contribute to market value, especially when acceleration charges or other extraordinary costs are involved. The principle of substitution states that no willing buyer will pay anything more for a property than they’d pay for a functionally equivalent substitute. It’s important to keep the principle of substitution in mind because people are paying so much more for labor today, and sale prices don’t typically adjust 100% when construction costs rise.

Therefore, it’s important to understand how to build a winning case for relief. It likely starts with a tax assessment protest to hold your local assessor accountable for rendering a fair and accurate value for your business property, especially during times of new construction or expansion.

What Can Business Owners Do?

We suggest two strategies for pursuing property tax relief for new and historical construction:

1. Investigate whether your property is correctly reported and classified, and whether all available exemptions are being applied.
2. Quantify market depreciation through common appraisal approaches.

Strategy #1:  Classification and Exemption Review

Just because you have costs on your books and records doesn’t mean that 100% of your asset totals should be reported, or assessed, for your real and personal property taxes. Assessors are supposed to consider cost less deprecation to estimate value. Both estimated cost and depreciation must be evaluated carefully and then applied correctly to arrive at a fair tax assessment.

If you have a lot of new construction costs hitting your books, you will want to investigate all of the construction components to ensure that nontaxable items are segregated prior to reporting taxable amounts to the jurisdiction.  Depreciation, which will be discussed in Strategy #2 below, should be fully vetted and quantified as well.

It’s important to understand that each state is unique in how it values certain property. This can also lead to more depreciation or favorable classifications, especially when it comes to personal property. Documenting appropriate asset valuation may involve some measure of capital project review and could require segregating historical capitalization to qualify your book assets for more advantageous property tax categories.

When investigating your project development costs, it’s important to identify project costs that involve environmental emissions compliance or containment at the state of federal level. If your business has been going green with a focus on emissions, we suggest evaluating these capital projects that, if state certified and exempted, will help permanently lower your property tax burden.

Real World Example

For a major food processor we’ve been looking at a particular state that has favorable exemptions for manufacturers in their industry. We’ve done a very detailed study to isolate property that qualifies for the exemption. Ultimately, we expect the food processor to receive permanent tax relief of $1 million to $2 million per year. This is something we see quite often when advising large industrial manufacturers, because their property tax burden is so high and because there’s so much equipment involved. Digging into the details, even at a cursory level, can yield substantial tax savings—often permanent savings.

You will be happy to know that some states reward growth through temporary tax abatement programs for expansion activities. Investigating and pursuing these programs can result in dramatic improvement to your bottom line for many years.

Finally, with respect to your real estate, ensuring that the correct property classification has been applied and that the assessed property reflects reality, can make a big difference in your assessment. I can’t tell you how many times we have seen “bricks and sticks” errors (i.e., square footage, construction date, ceiling height, etc.) made by local assessors during our assessment reviews. However, it typically requires a detailed survey of actual property features to highlight these mistakes. As a result, this kind of study involves more time than most business owners can spend to ensure that they are receiving fair, accurate, and equitable assessed values on their property.

So now that you have investigated your reportable basis, including favorable exemptions, classifications, and exclusions, what’s next?

Strategy #2:  Depreciation Review

Depreciation has a different meaning to business leaders than it does to appraisers.  Accountants are familiar with financial accounting depreciation concepts such as straight line, MACRS, alternative depreciation methods, asset life and term, etc. However, for valuation purposes, documenting and quantifying market value depreciation involves common real and personal property appraisal techniques. It starts with understanding the three forms of depreciation that establish the market value of real and personal property:

1. Physical depreciation pertains to wear and tear based on the elements. Symptoms of observed physical depreciation typically include repairs that are needed on roofing, siding, paving, etc.
2. Functional depreciation refers to obsolescence that is inherent in the property itself due to its design, which may be super adequate or inadequate to meet the needs of a typical buyer of the property. An example of inadequacy would include property ceiling heights that are insufficient for typical manufacturing standards. An example of super adequacy would include having property foundation thicknesses that are well in excess of typical user needs. Changing construction standards and comparing them to legacy standards that existed around the time that the property was constructed can also highlight some symptoms of functional obsolescence.
3. Economic depreciation relates to externalities that are impacting market demand for each property type. Studying overall market trends such as vacancies, transaction trends, cap rates, ratio of average list price to sales price, and lease rates are some factors that can highlight economic obsolescence.

Once the symptoms of each form of obsolescence are observed, typically by an experienced appraiser or other valuation expert, several types of analysis are used to document all forms of obsolescence:

1. Reviewing the ratio of typical construction cost to sale price and annualizing the differential based upon property age (age extraction).
2. Identifying deferred maintenance and observing condition during inspection.
3. Reviewing sales price trends of comparable properties.
4. Developing an income analysis through a review of landlord market rents, expenses, and cap rates.
5. Establishing market-based cost factors and estimating physical, functional, and economic obsolescence adjustments, and then adding land value estimates based upon a study of comparable land sales.

The idea is to support all forms of depreciation properly –functional, physical and economic –, to ensure that your overall value is correct. There are many ways to do this, but it all comes down to how much a property is appraised for.

As a hardworking business owner, ask yourself the following question: “If I put my property on the market on the assessment date, what kind of sale price could I expect assuming normal market exposure (i.e., listing time for a broker to sale) and typical consideration (i.e., cash or cash equivalent realized with the sale)? That should be a great starting point for determining whether you are getting a fair shake on your assessed market value.  However, that’s not always easy to determine for many commercial and industrial property types. That’s where having a seasoned navigator on your side is helpful since you really need an expert to guide you through the analysis.

Working the Process to Your Company’s Advantage

You probably sense that your property taxes are too high but aren’t sure how your business is being over-assessed or in what areas. With so many moving parts involved, how do you determine your correct property tax value?

Since most companies don’t have the resources to answer these questions in-house, and don’t have enough time to challenge their assessment through the protest or appeal process before their appeal deadline, the cycle of error and overpayment continues for years. That’s what assessors count on! But you owe it to yourself and your team to keep your assessors accountable through available appeals. Don’t keep overpaying your taxes year after year.

To evaluate and manage your property tax assessment levels correctly, use a seasoned navigator who is familiar with your property type and appeals process. He or she can identify and document assessed value errors, proper classifications, and exemptions. Sure, you can try to do the same kind of study yourself, but you’ll likely leave tax savings opportunities on the table and continue to overpay.

In case you are curious, here’s what a typical work plan looks like for many state reviews:

1. Review and evaluate property data – 1^st Quarter
2. Evaluate initial assessment data and engage assessor via open book process – 1^st Quarter
3. If needed, file local appeals – TBD, typically 2^nd Quarter
4. If needed, file state appeals – TBD, typically 2^nd Quarter
5. Complete exemption applications – TBD, typically 2^nd Quarter

As you can see, there are several deadlines and filings to document with a property tax evaluation plan. Scheduling and planning become increasingly complicated as your appeal is elevated to state or tax court levels where rules of discovery typically apply. For these reasons, we recommend bringing in the experience!

Conclusion

At times like these, assessors are looking at any legal means possible to increase property values. If they see a gargantuan construction permit within their jurisdiction, or if your company self-reports material changes on business personal property filings without uncovering every avenue to offset the impact legally, then a huge tax increase is likely to follow.

When it comes to business property taxes, the rules are complex, the timing is critical and the downside to an erroneous appeal can be significant. Don’t be a do-it-yourselfer here. Enlist a pro who understands your market and how it correlates to your specific property.  Your company’s pocketbook will thank you in the end!

Josh Malancuk, CPA, CMI is President of JM Tax Advocates, a service organization who advocates for property tax reductions and maximum level incentives for leading U.S. manufacturers and commercial property owners. He brings 28 years of specialized knowledge and experience to his clients. Josh can be contacted directly at joshua@jmtaxadvocates.com or at 317.674.8390×100.