Show Obsolescence to Help Achieve Successful Property Tax Appeals
By Angela Adolph, partner, Kean Miller LLP
Judith Viorst, author of the children’s book Alexander and the Terrible, Horrible, No Good, Very Bad Day, had nothing on 2020. By virtually every metric, 2020 was a terrible, horrible, no good, very bad year.
Taxpayers quickly learned that while most states have some sort of catastrophe exemption for property tax tying an abatement or reduction to a defined disaster event occurring that year, the provisions and requirements in these statutes are state-specific. Few states had any authority to address whether physical damage to the property was required for the taxpayer to receive any relief.
Most states eventually concluded that some form of physical damage was necessary for property values to be reduced following a disaster. Other states went the other direction, concluding that their disaster statutes did not require physical damage, only that the property be inoperable due to a declaration of emergency by the governor. Accordingly, property values for the 2020 tax year could be reduced in those states due to COVID-19-related economic losses.
Fortunately, 2021 gives all taxpayers a fresh start. Most states use Jan. 1 as the “lien date” or valuation date for determining fair market value of property subject to ad valorem tax. For income-producing properties, taxpayers now have a full year’s documentation of COVID-19 impacts, which more accurately demonstrates the fair market value of their properties in the current, COVID-19 economic climate. At a high level, such documentation may include financial statements with year-over-year and month-over-month comparison of revenues to expenses and profits to losses.
Drilling down, taxpayers should be able to demonstrate the source of these changing numbers, such as reduced employee hours, decreased production outputs and sales, unoccupied rooms, canceled conferences and the like. Comparable sales information should also now be available.
This information generally relates to economic obsolescence, which is a loss in value due to causes outside the property and which are not included in physical depreciation. Taxpayers also must consider whether their property exhibits functional obsolescence, or a loss in value due to the property’s lack of utility or desirability.
Functionality is tied to a property’s amenities, layout and current technology. A property’s functional obsolescence is measured through reduced or impaired use. Taxpayers can quantify the lack of use in 2020 and compare it to pre-2020 capacity and usage in arguing for a reduction in taxable value.
Historical information is key to the taxpayer’s case, as is evidence of adaptation to current market trends.
For instance, a year ago, who would have imagined that neighborhood and big box stores of all stripes would start delivering their products directly to customers’ homes? Suddenly, abundant check-out lanes, wide aisles, sampling stations and sprawling parking lots became unnecessary. Drive-thru lanes and carryout spots are now de rigueur.
Hotels have been similarly affected. Traditional amenities such as atria, loud restaurants crammed with tables and small, sophisticated lounges are passé. Motels with open-air access are enjoying a renaissance.
Resourceful restaurateurs have figured out how to make street-side dining desirable. Patios are now essential. While many of these changes in use may only be temporary, some are expected to be longer-lasting.
Consider commercial office space: Prior to the pandemic, many office-using employers permitted only limited remote working, but working from home has now become the “new normal.” Facility planners expect the traditional office environment to shift to a hybrid model, with expanded remote working, office-sharing and fewer in-person communications. Large conference rooms are out; state-of-the-art multimedia systems have taken their place.
These trends impact real estate values because they affect how property is used, or more importantly, not used. Commercial real estate developers will not be laying out offices the same way they used to, and hoteliers will not be building out the same large conference centers post-COVID. And the reality is that much existing buildout, furniture and equipment is going unused.
So for now, a replacement cost analysis is the most appropriate valuation method for those property types, because it reflects the functionality of the property and the fact that the property would not be rebuilt as-is.
Of course, as more and more businesses adapt to post-pandemic market trends, the lack of utilization may be deemed industry-wide rather than property-specific. At that point, the loss should probably be considered external (or economic) instead of functional.
In either case, taxpayers should be prepared to demonstrate the inutility of their property, and the cost of such inutility, to reduce taxable value.
This year may not turn out to be a wonderful, awesome, not bad, very good year. But at least taxpayers are now in a better position to present the sort of information that shows the adverse impact of a pandemic on fair market values. And if that translates to lower ad valorem tax liabilities, then this decade is off to a very good start.
— Angela Adolph is a partner in the law firm of Kean Miller LLP, the Louisiana member of American Property Tax Counsel, the national affiliation of property tax attorneys. This article originally appeared in the March/April issue of Northeast Real Estate Business magazine.