A business’s gross revenue increases may be limited because of economic downturns and/or competitive practices. In order to increase the bottom line of a business, expenses must be controlled. Some expense cuts have adverse consequences. For example, personnel cuts can affect sales and cause a decline in income that exceeds the savings in salary and benefits brought by the cuts. A savings is realized when expenses can be cut without affecting revenues. One place to save is to reduce the ad valorem tax on your client’s business.

What Is the Ad Valorem Tax?

The ad valorem tax is applied to the value of property (ad valorem means “against the value”). It is a principal source of revenue for cities and towns, counties, school districts and a variety of special tax districts. In its simplest form, it works as follows:

A city adopts a budget for its spending requirements. The city determines how much of its revenues must come from property tax and compares that amount to the total estimated value of taxable property in the jurisdiction, net of exemptions. The resulting ratio is the required tax rate, to be applied against the net taxable property.

Property Tax Rates

Property tax rates vary widely among jurisdictions within the United States, within each state and in many places within a county or town. As a wide range, the rate will be from half of one percent to five percent of the taxable property value. The rate of a particular tax jurisdiction may be based on its wealth and population, its demographics, its industry and the services it provides.

Uniqueness of States and Jurisdictions

Each state has its own property tax law that defines what property is taxable, what exemptions are allowable and how the law is to be administered. Accordingly, this article cannot attempt to describe all practices within the 50 states; rather, it is an effort to generalize.

Each jurisdiction (city, county, school district) may have a unique way of enforcing the state law that is imposed. It is especially frustrating that the rules followed by one jurisdiction — or results — obtained are not binding on another jurisdiction, even within the same state (except when imposed by a higher court; then stare decisis exists). The property owner needs to recognize that these differences exist and not expect the same results to occur in different jurisdictions.

Business Property Subject to Tax and Exemptions

Business property subject to tax and tax exemptions varies widely, generally regulated by state law.

Commercial and industrial buildings are taxed at market value by almost all jurisdictions. Some allow tax abatements for rehabilitation of an apartment building or for the construction of new commercial and industrial facilities that will increase employment. Often the abatements are phased out over a period of time, such as five years or 10 years.

About half of all states provide for an ad valorem tax on inventory. In those states inventory is generally taxed at market, which, for a retail store, is sometimes defined as what it would be worth in a sale as a unit to someone who would continue the business.

Less than half of the states subject intangibles to taxation. Because there is more than one type of intangible property, tax law provisions pertaining to intangibles should be studied carefully to determine taxability.

Some states provide for a tax on cash, accounts and notes receivable, stocks and bonds. These types of intangibles may have a value that can be measured independently from one’s own business. Intellectual property, such as patents and copyrights or unpatented or unprotected technology, may also be valuable.

In states that exempt intangibles, it is often important to distinguish the business value from the tangible property value. One of the best illustrations is found in a hotel:

Suppose a 100-room hotel has land, buildings, furniture and fixtures that can be replaced for $5 million, even though the hotel may be worth $20 million because of its brand name, reservation system, assembled workforce, including management, customer loyalty and loyalty programs. Thus, of its $20 million market value, only $5 million should be taxable in a state that exempts all intangibles. Note that separating the business value from the real estate is essential.

Relatively few states will apply ad valorem taxation to the going concern value or the goodwill of a business. But its owner or financial representative must examine what has been put on the tax rolls to be assured of fair treatment.

How to Protest an Assessment

The process to protest the ad valorem tax assessment on a home and business may vary widely among jurisdictions. Three issues to consider are:

1. When to Protest
   
   A protest may be warranted for any excessive valuation. It is especially effective where the benefit may have an effect for multiple years and/or in multiple locations.
   
   Some experienced real estate owners, including real estate investment trusts, protest the ad valorem tax on all their property every year. They may enlist the help of local experts who often work for a part of the savings (the owner has nothing to lose — but may gain upon favorable results). The owner wants to keep the tax assessor on guard — any increase in valuation will be met with a fight. This form of intimidation is similar to a sports coach who screams at the official on every play. Other owners will do research first, to determine their likelihood of success and estimate the cost of their effort.
2. What to Protest
   
   Most jurisdictions provide two separate conditions for a taxpayer to achieve a successful protest: market value and equalization.
   
   The market value argument is simple: The property’s assessed value exceeds the market value. Both sides may introduce data, supported by experts, as to the property’s market value.
   
   A second argument is equalization. Your complaint is that your property is being taxed at a higher effective valuation rate than similar property in the jurisdiction.
3. When to Stop Appealing
   
   Each jurisdiction will provide an appeals process. As the process deepens, the expenses of appeal will increase. You will need an increasingly expert team to assist at each level of appeal. Figure out likely tax savings; figure a maximum and minimum. Compare that range to the costs of time and money to be incurred in the appeals process. Decide when to quit.

And there you have it: what entails ad valorem tax, the uniqueness of states and their jurisdictions, the various exemptions and how to protest an assessment.

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