Jack Friedman

Ad Valorem Taxes in the Current Recession

Why they deserve CPA attention.

June 1, 2009
by Jack Friedman, CPA, ABV

The precipitous drop in real estate values in many cities can make property tax protests worthwhile. In larger municipalities, tax assessors  are spread thin across tens of thousands of properties and accounts, and they can’t keep up with rapid declines in value even if they wanted to do so (there are a number of reasons why tax assessors may be discouraged from posting reductions at lower values). As a consequence, owners who appeal property taxes can gain large savings, and a CPA’s effort to assist is most welcome.

Nearly everyone or every business uses real estate. Whether your clients are real estate owner/operators, or they own or lease commercial and industrial property used in their business, or they simply own their own home, they likely pay real estate taxes. Owners are obvious taxpayers; tenants often pay through a net lease or a lease escalation provision. Owners who are able to pass the burden to tenants should not forgo the opportunity to reduce taxes for their tenants.

The current timing for a CPA to begin to assist might be ideal because CPAs tend to have greater time availability in the summer months when audit and income tax workloads are reduced. While the task can start now, completion may occur later.

Property Tax Laws

Property tax laws vary greatly from one state to another, so CPA Insider™ readers are forewarned that generalizations offered in this article may not be applicable to the their jurisdictions.

Some of the major issues include:

  • Representation Requirements

    In some states, including my home state of Texas, property tax representatives must first secure a license. However, attorneys and CPAs are exempt from licensure, so either professional can represent a property owner, at least at levels prior to trial, where nearly all matters are resolved. The cost of litigation can be exorbitant, with neither side wanting to go that route except in very high-stakes matters or to set a precedent. So, as a practical matter, a CPA can represent a client who protests ad valorem tax values. In many situations, however, an attorney or CPA may suggest use of an experienced tax representative or a qualified appraiser, especially for unique or challenging issues.
  • Fees From Clients

    Most CPAs are accustomed to charging hourly rates no matter how successful the outcome. Generally, the CPA is not an advocate, so compensation determined by success may create a conflict of interest. But many clients do not want to pay for an unsuccessful tax challenge. Attorneys and tax representatives are often advocates and have various incentive agreements. It is not unusual for their compensation arrangement to be a fraction (often 30% to 40%) of the tax savings over the first two years after appeal.

    Whether you are an advocate or are permitted incentive compensation may depend on your other client efforts, state law and professional ethics. In many situations, the CPA’s comfort zone of hourly rates may work best.
  • Taxable Property

    Every state has a property tax code. Though not as complex as the federal Internal Revenue Code (IRC), it will likely have many nuances.

    For example, taxation of intangible property still occurs in some states. In states that exempt intangibles the issue of what an intangible is and how it is valued may be hotly contested. Clearly, cash, accounts receivable, bonds and notes are intangible. Same for copyrights, patents and trademarks, though valuations can be subjective.

    In many states, hotel and motel representatives have successfully argued that their franchise affiliation (flag), reservation system and business enterprise value are exempt intangibles. Regional malls’ representatives also claim that a large part of their total value is an exempt intangible, created by synergy and lease-operating covenants.

    Computer software is an exempt intangible in many states, and some appraisers have been resourceful in elevating its value, then subtracting extensive amounts from the unit value of a railroad or utility. The “unit” value is the value of the entire business, which is allocated to areas in which it operates. Public utilities and railroads are assessed as a unit in most states.
  • Market Value or Equalization

    Property is usually taxed at market value or a set fraction of market value, before deducting exemptions. The state may have a unique definition of market value for the specific type of property. For example, the Texas Property Tax Code reads that the value of inventory is “the price for which it would sell as a unit to a purchaser who would continue the business.” Who knows what that means?

    Many assessors will accept rather crude measurements in lieu of a full-blown MAI (Member of the Appraisal Institute) appraisal. For example, the assessor may accept a motel valuation on a per-room basis. That is, the assessment is principally based on a price per room, almost without regard to the occupancy rate or daily room-rate of the subject property. The same applies to apartments (per-unit) or office space (per square-foot).

    In many jurisdictions, a taxpayer can get relief even when the property is assessed below market value by pointing to lower-taxed similarly situated properties, known as equalization. Suppose most apartment complexes in a jurisdiction are assessed at 80 percent of market value, but your client’s apartment complex is assessed at 90 percent of market value. Your client has a right to a reduction to 80 percent because others in the same area are assessed at the lower rate.
  • Exemptions

    Various property tax exemptions are provided for property owned by religious, educational and charitable organizations, and for certain types of property such as environmentally impaired land. Many states, including Texas, apply value in use to agricultural land or open-space land, with a tax rollback if converted to another use within a specified period of time.

    Several states not only tax inventory, but often assess it at book value. In some situations, year-end inventory may have a market value — as defined by the tax code — that is less than U.S. GAAP (Generally Accepted Accounting Principles) book value. The inventory should then be assessed at lower than GAAP, but tax assessors often resist. Note that market value for tax purposes is not the same as “lower of cost or market” under GAAP.

Meet Clients

The present can be a good time to review client files to determine which clients would have the most to gain from a property tax review. Then prepare a plan and meet with your client to gain authorization.

In many situations, after some study and preparation, assessors will sit down with you and resolve the issue amicably. In this recession, with many businesses experiencing reduced sales, expense savings provide important opportunities for a client’s business to maintain earnings.

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Jack P. Friedman, PhD, is a real estate author, appraiser, and economist in Dallas, Texas. He holds the CPA, ABV, CFF and is a state-certified appraiser, with ASA, MAI and CRE designations. Contact him at  www.realexperts.com.