Despite assurances that an economic recovery is underway, corporate tax departments are searching for ways to lower their companies’ tax expense and to operate more efficiently. A poll in May 2010 by the Tax & Accounting business of Thomson Reuters revealed that more than half of respondents expect their companies’ property tax burden either to remain the same or to increase compared to last year. The survey results reflect an overall sentiment that property tax no longer offers a big opportunity for savings. What many companies may not realize, however, is that since property tax is based on value at a specific point in time, there remain significant tax savings opportunities, especially in areas were property values have declined.
Don’t Expect Your Taxing Jurisdiction to Inform You of Tax Breaks
Despite some business property tax reductions in recent years, property tax is still a top tax revenue generator for states, generating $168 billion collectively in the fourth quarter of 2009. (U.S. Census Bureau, “Quarterly Summary of State and Local Government Tax Revenue,” December 2009). Keep in mind that 48 states are still facing budget deficits — which have a trickle-down effect on local government — and all indications are that they will face shortfalls as big as or bigger than they faced this year in the 2011 fiscal year. Accordingly, it is not surprising that taxing jurisdictions are not actively promoting how companies can lower their property tax liability. This means that it is up to individual companies to seek out available exemption and reduction opportunities.
Property Tax Complexity
With more than 13,000 taxing jurisdiction in the United States, each with varying rules and methodologies on how property is taxed, managing a company’s property tax burden can be a cumbersome process.
If a company only has a few assets in a few jurisdictions, the process is manageable. For larger companies with hundreds or thousands of assets spread across multiple locations, however, cost effectively managing property tax compliance in-house can be extremely difficult. There are myriad differences among taxing jurisdictions in terms of their taxable property and exemptions, the calendar of deadlines for reports and payments, and the timing and process for negotiating and appealing assessed value. These factors all contribute to the complexity and risk of managing a property tax function. In addition, misconceptions about valuation methodologies and the appropriate adjustments for underperforming properties compound the confusion.
Property Tax Myths
Myth: Property tax is a legal issue, not a valuation issue
Truth: Less than five percent are legal issues
Myth: You must be an attorney to file tax appeals
Truth: This is only applies in certain states
Myth: Taxable personal property equals total balance sheet
Truth: Capitalized costs may include many non-taxable items
Myth: Appraisals are necessary for all tax appeals
Truth: Only in certain states and venues, but solid documentation is key
Myth: The only way to get a tax reduction is to file a formal appeal
Truth: Much can be accomplished informally
Property Tax Opportunities
Property assessment is based on market value at a specific point in time (January 1 in most states), so even though the economy is improving overall in many regions and industry sectors, the values for current year property tax purposes are typically based on market conditions existing months ago on the assessment date.
With this knowledge in hand, the next step is to educate company’s management on the various factors that can affect property tax assessments for both real and personal property. As a general rule of thumb, the more assets a company owns, the higher the degree of complexity and the more education needed to realize maximum benefits. Even without knowing the specifics of various tax laws in a particular region, however, there are steps that can be taken to save a company tens of thousands or perhaps even hundreds of thousands of dollars in property taxes.
For real property (e.g., land and buildings), the company should identify and analyze a list of sales comparables to ensure a fair assessment is made. Many assessors might not have access to a full array of recent, verified, arms-length sales comparables. A thorough search for comparables is particularly important during times of economic change and fewer market transactions.
Don’t forget deferred maintenance. If a company deferred maintenance on property in an effort to preserve cash flow and weather the recession, this can affect values as well. For example, a company may have delayed the replacement of a roof, or upgrading the lighting, which could lessen the value the property compared to other buildings in the area. The company should also take account for reduced rent. If a business has income producing property like an office building or apartment, for example, and has reduced rent to retain its tenants, this could affect the value.
For personal property, such as equipment, the company should identify and document lower asset utilization. If a company has a piece of manufacturing equipment that is underutilized compared with capacity or historical operation, this can lower the value of the equipment.
Remember to consider slow-moving inventory in states that tax inventory. If a company has excess inventory on hand, and has reflected the adjustments on its balance sheet, many states will allow adjustments to taxable value. The company should strive to maximize exemptions. For example, there are 33 states with some type of property tax exemption or beneficial treatment for qualifying pollution control assets. Other exemptions may apply to certain software or categories of inventory. Exemptions are very specific to the various jurisdictions.
If a company’s goal is to leave no stone unturned in the quest to save money, there are certain best practices that can advance this goal as it relates to property tax. In addition, many companies could likely achieve savings by establishing (or rigorously following) best practices to streamline property tax compliance. First, the company should document its procedures for identifying, tracking, reporting, and paying property taxes so that future processes are more efficient. (Such documentation can also enhance accuracy in filings and prevent “red flags,” which could trigger an audit.)
The following steps are key in creating property tax best practices:
- Educate corporate and facility personnel on how they can help influence the amount of property tax the company pays. Involve all the stakeholders including finance, planning, asset accounting, plant manager and controller, and facilities, maintenance, and environmental engineers. Show them examples of the tax effect of successfully translating their issues into opportunities.
- Understand the company’s accounting and capitalization policy, especially as it relates to costs such as equipment rebuilds, overhauls, modifications, and upgrades. Develop consistent rules for property tax reporting of these unique costs. How much taxable value do these expenditures really add?
- Speak with personnel each year before filing to discuss the prior year’s capital additions. Asset descriptions are not always what they seem. Make sure there is an understanding of each capitalized asset. Be persistent. Ask questions until the right answer emerges. Clearly document decisions for taxability, classification, depreciable life, and any unique circumstances affecting valuation. This work in advance will simplify subsequent audits (and guard against surprises).
- Evaluate the details in the company’s construction-work-in-progress (CWIP) holding account, identifying any costs that are not directly associated with tangible assets on site on the assessment date. Look for circumstances such as progress payments, feasibility and engineering studies, equipment purchased but not received, and capital projects that were cancelled or deferred. Report only what is taxable.
- Understand how the company’s inventory book values are determined. Confirm whether these values are consistent with the state’s definition of market value. Ensure that all inventory booked to a location is actually there and, further, that any off-site inventory subject to tax is identified and reported.
- Review the company’s real property assessments annually to keep tuned to market changes. In today’s economic environment and unsettled real estate markets, things can change quickly. Look at comparable sales and assessments to identify inequities. Make sure the comps are truly comparable, or are appropriately adjusted. This may require the company to look beyond the local market for large and special-purpose properties.
- Identify, measure, and document all forms of functional and external obsolescence. Obsolescence is more common than usually thought, but it does take time, savvy technical skills, creativity, and persuasion to maximize this benefit year in and year out. This is not a one-time exercise; it is an ongoing process.
- Work the network of property tax professionals. Talk with colleagues in other companies, as well as consultants, attorneys, appraisers, and brokers. Stay current on industry issues and trends. Subscribe to industry publications and email newsletters. Search for answers. Challenge yourself to find the missing pieces of the puzzle.
- Don’t hesitate to discuss, negotiate, and appeal the assessed values if the company has solid evidence and a compelling case. It is the company’s property and odds are that the company knows more about its value than any government entity.
- Managing property assessments, especially on major properties, is a year-round process. Find reasons to periodically meet, email, or call your assessors. Keep them apprised of changes and issues as they evolve, and well in advance of when you need to address them. Communication is key.
As the economy improves, many businesses may believe that they have maxed out their efforts to reduce property tax liabilities. But with various and changing property tax laws across state and local jurisdictions, as well as a plethora of existing exemptions, some businesses are not aware of the many opportunities still available to reduce their liability. Businesses need to carefully review their assessed values during this time of economic change to make sure they are fully maximizing potential property tax breaks available to them.
Appendix: Case Study
Background
- A manufacturing plant, operating in California since the 1940s, houses administrative, processing, and assembly operations.
- Located in an industrial area with redevelopment potential, more than 80 acres with 37 individual buildings and other structures containing 1.7 million square feet.
- Real and personal property appeals were filed for 2007-2009.
Plant Issues
- Significant and extended drop in customer orders forced facility to curtail operations, reduce workforce and consolidate space, with large portions of plant underutilized.
- Market conditions and foreign competition forced company to move much of the manufacturing operation outside of the United States to achieve lower cost of production.
- County real estate records were outdated because of continual facility changes.
Challenges to Overcome
- Multiple and complex valuation issues that shifted over time required a large amount of analysis and documentation. The report and conclusion had to be simplified and clearly articulated to facilitate practical valuation adjustments for each year.
- Because of high initial assessed values and the multiple years under appeal, the Assessor was initially reluctant to consider a significant adjustment.
- The economic conditions of the County and State of California, and a substantial backlog of pending appeals, caused significant delay in the Assessor’s review and approval process.
Key Value Adjustment Opportunities
- Idle and underutilized equipment and buildings.
- Buildings vacated and demolished.
- Uneconomic internal facility.
- Unique characteristics of specialized assets and construction work in progress (CWIP).
- Inefficient facility layout and production equipment with high operating costs.
Resolution and Results
- Following more than two years of persistent contact and negotiations with the Assessor’s office, and after multiple rounds of supplemental data and analysis, an agreement on the following was reached:
- External obsolescence adjustments of 25-35 percent applied to the manufacturing equipment and CWIP.
- Functional obsolescence adjustments applied to some buildings and equipment.
- Utilities facility valued at nominal residual value.
- Removed demolished buildings from the assessment roll.
Resolution of the appeals occurred in early 2010:
- Avoided additional time, expense, and delay of formal hearings.
- $600,000 tax refund, including interest, for the 3 years of appeals.
- Agreed to valuation methodology applicable to 2010 and future years.
- Established categorization and valuation concepts which will facilitate more efficient completion of a future audit.
Key Success Factors:
- Educated stakeholders at the plant site and won their involvement throughout the process: plant manager, controller, division and finance VPs, engineering, environmental, and asset managers.
- Incorporated a variety of methodologies to support the value adjustments: asset classifications and useful lives, effective age analysis, external and functional obsolescence.
- Earned the trust of the Assessor’s staff by pointing out the Assessor’s erroneous omission of an entire category of equipment which taxpayer had reported on the return.
- Communicated regularly with corporate, plant and local Assessor staff from both the Real Property and Personal Property
Departments.
Jeff Moore is Director, Complex Property Tax for the Tax and Accounting business of Thomson Reuters. He has more than 25 years of property tax experience, specializing in multistate outsourcing engagements and valuation analysis for personal property, machinery and equipment, and process-oriented facilities. Mr. Moore has a B.A. degree from Skid-more College and an M.S. degree from the University of Arizona. He may be contacted at jeff.moore@thomsonreuters.com.
Joseph Glennon is Director, Complex Property Tax for the Tax and Accounting business of Thomson Reuters. He has more than 17 years of property tax experience, working with large multistate companies to manage and reduce property taxes. Mr. Glennon has a B.S. degree from DePaul University and a CMI certificate from the Institute for Professionals in Taxation. He may be contacted at joe.glennon@thomsonreuters.com.
- Thomson Reuters press release, “The Tax and Accounting Business of Thomson Reuters Reveals Results from Business Property Tax Survey,” May 2010.
- Center on Budget and Policy Priorities, “Recession Continues to Batter State Budgets; State Responses Could Slow Recovery,” February 25, 2010.