Reducing Property Taxes Can Save You a Bundle

Since the pandemic, franchisors and franchisees have been forced to severely cut costs, give discounts to customers, and demand concessions from landlords, lenders, and suppliers to financially survive. Many closed or imposed limited hours on operations with a skeleton crew. Others moved forward in aligning revenue with costs by localizing suppliers, paying off or restructuring royalty fee deferrals, refinancing loans, selling locations, outsourcing project management, and renegotiating contracts for services of all kinds.

Operators continue to need avenues to save money and improve cash flow, but they often ignore the largest expense they have: property tax. Every year, operators are forced to endure property tax’s financial hammer. Operators tend to treat property taxes as an annual fixed line-item expense when they, in fact, are disregarding an opportunity to save a significant amount of cash that could otherwise be allocated toward saving and growing their businesses.

While the financial responsibility to satisfy a property tax bill typically falls on the property owner, a commercial tenant such as a franchisee may be contractually obligated to pay the property tax on behalf of the property owner. By way of example, a commercial tenant is generally required to satisfy a property tax bill if it engages in a “net lease,” which is defined as a commercial lease agreement whereby the tenant must pay all property-related expenses, including property taxes.

Further, although standard commercial leases or gross leases don’t require tenants to pay property taxes per se, they do force tenants to pay property taxes through the rental payment, albeit indirectly. Standard long-term commercial leases tend to have an integrated rental schedule that increases over the course of the lease term to account for any year-over-year increases in the property tax rate. Therefore, both property owners and lessees should be aligned in their desire to alleviate the burden on their businesses that property tax imposes.

Property tax is based on fair market value. While some states differ in their definitions of market value to an extent, fair market value is generally defined as the value that an informed and willing buyer would pay to an informed and willing seller in an open and competitive real estate market.

Assessed value is the taxable value – in other words, the value the local government uses to calculate property taxes. To obtain a reduction in assessed value, thereby reducing their property taxes, an operator must file an appeal with the local government.

All states have deadlines for beginning the appellate process. Missing those deadlines is fatal and results in the forfeiture of the operator’s right to appeal. At the initial stage, states typically require the operator to file a protest with the local government. After the protest is filed, a hearing is set before the local appraisal review board. If an operator is unsatisfied with the board’s decision, they may file an appeal with the district court.

Income-producing properties are the most common type of property used to facilitate the operation of small businesses. Assessed value is based on a myriad of factors, but among the most critical are income generation and income potential, location, physical condition and age, economic variables, and depreciation. The opportunity to challenge a property tax assessment should not be ignored.

The following are factors to keep in mind when evaluating the opportunity to reduce your property tax burden.

1) Location

Prime locations that offer convenience, high foot traffic, and ease of transportation (access to highways and freeways, transit systems, and parking) generally command higher market values, while less desirable locations decrease market values.

The hotel sector, which has been described as “hyperlocal” when market value is at issue, offers a good example. Subtle differences in proximity to airports, hospitals, office buildings, or sporting facilities have a profound effect on a hotel’s market value. For example, two luxury hotel properties may lie in the same submarket, be relatively close together, and operate in the same metropolitan area. However, the hotel property closer to the airport will likely produce more income because of higher foot traffic. As its income increases, so does its market value.

2) Physical condition & age

Modern facilities that are properly maintained generally command a higher market value, while properties that are older or not so well-maintained are typically assessed at a lower market value. The degree of maintenance is often considered during the appraisal process. Deferred maintenance is best understood as a deficiency that requires repairs that are deferred to a later date. The extent of these repairs ranges from chipped paint to foundational issues, which can prove to be of great cost to the operator. Typically, the cost of correcting or repairing the deficiency is deducted from the property’s market value. Evidence of deferred maintenance typically comes in the form of invoices reflecting the cost of labor and materials necessary to remedy the deficiency.

3) Economic variables

Economic variables, such as the interplay between supply and demand, play an important role during the appraisal process. At its most basic level, when the supply or availability of a specific type of property is low and the demand for such property is high, market values generally increase. Conversely, when supply is high and demand low, market values tend to decrease.

Some properties, such as those in the retail sector, are hypersensitive to certain economic shifts. Since the pandemic, e-commerce has become more prevalent, causing a sharp decline in market values in the retail sector. As online shopping becomes a norm, businesses are forced to adapt and focus their resources on providing an online platform that consumers can use to purchase goods. Consequently, those businesses must seek warehouses and distribution centers to package, store, and ship those goods to its customers. Then, in turn, demand for those property types increases, while demand for retail properties decreases.

4) Depreciation

Depreciation is a notable factor incorporated into the equation that appraisers use to formulate value, which is narrowed down to physical deterioration, economic obsolescence, and functional obsolescence.

Physical deterioration often includes the impact of continued use of the property, physical wear and tear over time, and the elements of nature.

Economic obsolescence is best understood as the reduction in value of the property from the impact of conditions external to and not controlled by the operator or the operation of the property. Typical examples of economic obsolescence include proximity to undesirable locations such as high-crime areas, a recession, or zoning changes. To exhibit economic obsolescence, an operator may present documentation that reflects financial statements with month-over-month or year-over-year comparisons of profits to losses and revenues to expenses. A deep dive into those financial statements may reveal decreased sales and production output, reduced inventory, reduced employee hours, or occupancy-related information such as unoccupied rooms.

From a barebones perspective, functional obsolescence involves the impairment of functional utility or desirability contributing to the loss in value of the property. This form of obsolescence is generally exemplified through a property’s outdated design, lack of amenities, poor construction, and, often, simple old age. Many operators measure functional obsolescence by quantifying excess capital costs and excess operating costs through a year-over-year analysis.

Conclusion

Property tax is granular and is riddled with complexities and nuances, especially when the market value of income-producing properties is in dispute. Now is the time for all business operators to assess whether a reduction in property tax can play a significant role in the financial survival of the business. Partnering with an experienced consultant or attorney will streamline the appellate process and help ensure a reduction in the operator’s property taxes.

Alex Mazero is a tax litigation attorney with Ryan Law Firm, which specializes in federal, state, and local tax litigation. Contact him at 469-500-6956 or alex.mazero@ryanlawyers.com