Tax Assessments Based on Value in Use, or Value in Exchange
Know Your Jurisdiction
By David Chitlik, Vice President, Atlus Hospitality Tax Group
Regardless of property type, tax assessment valuation would appear simple enough. A generally accepted definition of market value is:
The probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.
This definition comes from the Appraisal Institute and it closely matches the definition provided by the International Association of Assessing Officers. Buyer and seller arrive at a price based on their own determinations of the highest and best use of the property. Most assessors in the US will include the recent sales data that has occurred in their jurisdiction with other market indicators and trends to arrive at the assessments for the taxable properties in their jurisdiction.
This process is called "value-in-exchange." Approximately 90 percent of residential and commercial real estate tax valuations are determined in this manner. Additionally, as noted above, assessors must consider what the highest and best use is for the subject property, regardless of what the buyer may have in mind. A basic definition for highest and best use, again from the Appraisal Institute:
The reasonably probable use that produces the most benefits and highest land value at any given time.
While most tax assessments are based on that analysis, as well as the value-in-exchange concept, what if the law requires the assessor to overlook the highest and best use determination? How then does the assessor evaluate the market value of the property? In a few jurisdictions, most assessments are based on the existing use regardless of the possibility of higher value alternatives.
That is the concept of "value-in-use," and it's typically an exception to the fair market rule. Value-in-use is defined as the value "a specific property has for a specific use… without regard to the highest and best use of the property or the monetary amount that might be realized from its sale."
This is not a new idea in the valuation domain. And, all 50 states have some variation of value-in-use rules in place for property tax assessments considered unique or special in that jurisdiction. However, most states restrict its application to agricultural property. This practice is based on government policy that helps keep agricultural values, and the resulting taxes, lower than they would be based on going market rates. It is primarily meant to benefit family farms but can apply to any agricultural land, or designated open space. Open space, including golf courses, is also a beneficiary of these special provisions. There is a caveat to benefitting from these policies. If the agricultural land or open space becomes developed for commercial use (say, farmland sold for a residential subdivision or a golf course sold for apartment development), most jurisdictions will require the taxpayer to retroactively pay the difference between the value-in-use-based taxes and the resulting market value taxes. This is typically referred to as a tax rollback or clawback requirement that occurs when the use changes.
When it comes to challenging an erroneous value-in-use assessment, much of the process remains the same as appealing a fair market value assessment. However, there are slightly different rules and possibly exceptions to the standard process. This is where one really needs to know the jurisdiction's regulations and standard practices with respect to the process. Once the taxpayer has this understanding, the appeal can be successful. Taxes can be saved.
A perfect example of a value-in-use real estate tax appeal not based on an agricultural or open space property is the case of Marriott's former Mountain Shadows Resort, which was located in Paradise Valley, a tony section of Phoenix. The well-known resort included a golf course, 43 acres of land and an older, deteriorating hotel.
Marriott continued to operate the hotel even with significant increases in capital expenditures and rooms that were often out of service. Reportedly, the resort's ancient pipes even struggled to regularly deliver clean water to the resort buildings.
Maricopa County assessors determined the site was worth about $25 million if the hotel were torn down and the acreage subdivided into prime residential lots. Marriott's real estate tax bill reflected that opinion. Marriott appealed the higher assessment. During the initial stages of the case, Marriott's valuation expert determined Mountain Shadows was worth only about $7 million as an operating resort - $4-5 million for the hotel alone, with the remainder attributable to land.
The initial phase of the appeal was to the local appeals board. Marriott was unsuccessful in arguing for the lower value, stating that it didn't want to tear down a financially feasible, operating hotel. The case carried into a state court, which overruled Maricopa County, saying a governmental authority had no right in Arizona to dictate the highest and best use of an owner's property.
This unique Arizona value-in-use rule saved Marriott and the hotel owners significant money.
There are cases in other states where the value-in-use concept has been considered and/or litigated, with valuations determined in both directions.
In Oregon, the state Supreme Court ruled "if a property has no immediate market value, its real market value is the amount of money that would justly compensate the owner for loss of the property." In other words, the valuation should be based on value-in-use, rather than value-in-exchange.
In Lehigh, Pa., the FM Schaffer Brewery argued successfully that its 791,382-square-foot facility and the property on which it was built was worth only $9.5 million on the open market. The assessor determined it was worth $34 million to Schaeffer. The Pennsylvania Supreme Court decided in favor of the brewer, setting the assessed value at $9.5 million.
Another situation in which value-in-use comes into play includes properties with significant physical or economic obsolescence. In a value-in-use state, a hotel may have deteriorated functionally or economically, because a new road has rendered the hotel off the beaten path and therefore unlikely to be a first choice for guests. However, it continues to operate and the assessment would reflect that lower value.
But, in a state that bases its appraisals solely on value-in-exchange, an assessor may argue that, although the hotel's receipts are down, new houses are being built all around the immediate neighborhood or market. Therefore, the land may be worth more upon sale than the entire operating hotel. It is worth noting, however, that some states, Virginia as an example, have laws limiting using speculative data to determine tax assessments. This acts as a circuit-breaker for extreme spikes in tax assessments from year to year.
That's not all - still another issue can come into play here. Assessors in most tax jurisdictions often start on a value-in-use assumption until either the property is sold or altered in some way that would bring it to the attention of the assessor. For example, an application for a zoning change or a building permit. Those moves can trigger a new look at the property and, often, a new determination of highest-and-best use value.
These types of use changes may be time sensitive. Because assessments are "locked in" as of a specific effective date, a building permit or certificate of occupancy that is issued on December 31, versus January 2, may trigger an extra year of higher taxes. This is the procedure in Florida - one more reason to know your jurisdiction.
The primary issue here is that property tax is state and/or locally driven. Local jurisdictions have their own rules and regulations that impact your properties, whether across one state, or many states. So, you need to know the rules for each jurisdiction in which you operate or retain tax professionals who do. Regardless of whether or not you routinely appeal your assessments, you need to be aware of the challenges associated with different jurisdiction assessment practices. It's the only way you can be certain your properties are being treated fairly.
David J. Chitlik, CAE, has extensive experience in all facets of the property tax assessment and appeal industry. Prior to joining Altus Group, he spent 18 years as the Director, then Senior Director, of the Property Tax Department at Marriott International. Initially he oversaw a staff of more than 20 associates working on both sales and property tax compliance, appeals and audits. Mr. Chitlik has many years of property tax consulting experience as well, first with Tenenbaum Hill & Associates, Inc. and then Marvin F. Poer & Company. He was the Managing Director for the Mid-Atlantic Regional Office for both companies with a combined 11 years with both firms. Mr. Chitlik can be contacted at firstname.lastname@example.org Please visit http://www.altusgroup.com/ for more information. Extended Bio...
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