Don’t worry about challenging a property tax value that is less than the taxpayer’s purchase price, right? Wrong! There are numerous factors that distinguish a purchase price from a taxable assessed value, and the failure to closely review an assessment can cost a property owner dearly.
The legal standard for determining property tax values can differ from state to state, but it is generally equivalent to fair market value. That is the probable price that the property would bring in a voluntary, arms-length transaction between a willing and knowledgeable buyer and seller, in an open and competitive market, with neither party being under undue duress, as of the valuation date.
While it is possible for a purchase price to be the same or similar to market value, there are many instances where the two deviate. Here are some common examples:
Related Parties Sales
A sale is not an arms-length market transaction if it occurs between related parties and isn’t exposed to the open market. A sale between a company and its subsidiary, for example, may not reflect fair market value.
Fee Simple vs. Leased Fee
For property tax purposes, fair market value is most often based on the fee simple estate, unencumbered by leases or other third party interests in the property. If the property is subject to an above-market lease, perhaps in a sale/leaseback transaction, the leased fee purchase price might greatly exceed the property’s fee simple valuation used for assessment purposes.
Portfolio Sales and Mergers & Acquisitions
A transfer of real estate in connection with a merger or acquisition is not a market transaction with respect to that particular property. Likewise, an assessor shouldn’t use the sales price for a portfolio of properties, which might be bundled together and marketed as a whole, to determine the market value of one small component of the transaction. Although buyers regularly make purchase price allocations for these types of transactions, such allocations are not synonymous with fair market value standards used for assessment purposes.
Unique Sales Terms
Sellers and buyers often think outside the box to close a deal. Seller concessions come in all shapes and sizes and can drastically affect the final purchase price. For instance, a seller may agree to provide certain services or take on additional obligations after closing that would not be part of a typical market transaction.
1031 Exchanges
Buyers motivated to defer substantial income tax liability by executing a 1031 exchange before a deadline may pay above-market prices.
Special Financing Terms/Institutional Investors
The purchase price may be artificially inflated because of unusual or favorable financing terms. Institutional investors, with greater access to the capital markets, are able to obtain more favorable financing terms than the average market participant. This lower cost of capital allows the institutional investor to pay above-market prices on lower cap rates in order to beat out competing bidders, while still achieving the same return as the typical investor.
Construction Costs and Non-Real Estate Investments
Developers and expanding businesses often find their projects detailed in the newspaper, with anticipated costs or total project investment. Often these amounts include expenses not associated with the real estate, such as equipment, employee training and the like. And just because something costs a certain amount to build does not mean it can be sold for a similar price.
Declining Market
Markets heat up and markets cool down. Overpaying at the height of the market may mean a poor return, but this should not justify an over assessment.
A prudent assessor looks beyond the price to determine if a sale is a true, market-value transaction. Despite the best intentions, even the most diligent assessor cannot account for all of the factors that can skew a sale price away from market value. Referencing non-market deals for comparison will erroneously influence the sales data and can lead to artificially higher assessments. The assessor’s reliance on an assumed purchase price for the subject property can have an even more dramatic and costly effect on that taxpayer’s assessment.
Many states charge a transfer or privilege tax to record a deed, which may require the buyer or seller to disclose a purchase price. Assessors will look at these stated purchase prices and will quickly flag any that are higher than the assessed value. A taxpayer should consult with local counsel to avoid overstating the purchase price. For instance, a purchase price may include personal property, intangibles, or perhaps additional real estate that should not be included in the consideration amount required to be disclosed.
Real estate brokers should not be surprised when contacted by assessors or subscription services to confirm details of a sale. Before quickly confirming a sale as a market transaction, the broker should be mindful of the issues discussed in this article. The failure to do so might significantly increase the purchaser’s future tax assessment.
All real estate investors should have a property tax review plan in place, with professionals knowledgeable of local valuation standards, rules and procedures. When purchasing or developing real estate, remember to provide your tax professional with the particulars of the transactions, including any reasons why the purchase price or investment may not indicate market value.
Always keep in mind that purchase price and market value are not synonymous, so there is no need to concede a high assessment without first looking beyond the price on the deed.
Aaron D. Vansant is a partner in the law firm of DonovanFingar, LLC, the Alabama member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at [email protected].