What You Need to Know: Strategies to Lower Your Property Taxes on Your Commercial Property in a Troubled Economy
By: JUDY S. ENGEL
February 2010
Year after year, the same thing happens: you open your property tax bill and it keeps going up, up, up. It does not have to go up and, in today’s economy, it should not. Published sources suggest that commercial real estate values in some areas are down by nearly 50 percent from their 2007 peak but that assessments have not gone down proportionately. This article explains why and maps out how to reduce your property tax bills now and into the future.
Property taxes in Minnesota are based on the value of the real property. Assessors will value your commercial real estate using a combination of three methods: (1) estimating the depreciated cost to build the building; (2) looking at the price-per-square-foot for comparable-building sales; and (3) estimating how much money the real property assets of your building earn and capitalizing that stream of income into the value. Identifying the value of the real estate alone using these three methods can be difficult in many commercial properties because value also is often found in non-taxable personal property and intangible assets—including items like furniture and fixtures and intangible assets like chain affiliation, reputation, franchise rights, and in-place workforce—depending on property type.
The first valuation method (cost approach) is the only approach that does not include the value of personal property or intangibles, since the approach is that the assessor is valuing only land and “bricks and mortar.” This cost approach does not work well for older buildings since industry designs, construction techniques, and building costs change so significantly over time. The cost approach can also be problematic for newer buildings with higher building costs, especially in a troubled economy. As anyone who built a commercial property in 2007/2008 likely knows well, cost does not necessarily equate to value. In newer properties, the difference between cost and value is often due to something called external obsolescence. External obsolescence is a negative impact on property value due to external forces, such as market conditions during an economic recession. Unfortunately, assessors often ignore external obsolescence in establishing taxable value, especially in newer properties, even when changes in economic trends and forces are fairly indisputable.
The second valuation method (sales comparison approach) can also be problematic. Many commercial properties are sold as operating businesses subject to long-term leases. Accordingly, sale prices may include significant amounts of intangible assets and personal property such as furniture, fixtures, and equipment. Also, when a property is subject to long-term lease, the buyer is purchasing the income stream from the lease, not the bricks and mortar alone. Assessors often fail to consider and adjust for these significant amounts of non-taxable assets often included as a part of the sale transaction, ultimately leading to over-assessment and over-taxation of the real property component.
Because the purpose of owning real estate is often to earn income, buyers, sellers, and appraisers of commercial properties often focus very heavily on the third valuation method (income approach). As with the other two valuation approaches, the income approach is not without problems when it comes to segregating the value of the real property components. The problem stems from the fact that in some types of commercial properties, such as hotels or retail properties, some of the income stream derives from non-real property components of the property (e.g., income from in-room entertainment, vending machines, or laundry service; or from amortized tenant improvements). The income stream from such services is not income derived from the real property, but rather is income from personal property, services, or other business income that should be excluded from real property. Many assessors ignore these fundamental deductions when establishing the taxable value of commercial real estate.
So, how do you ensure that the assessor is fairly valuing your property? The answer is simple: know your property and its components and pay close attention to tax notices you receive. If the assessor does not listen to reason, then file a property tax petition with the Minnesota Tax Court.
In Minnesota, property taxes are paid in arrears, meaning that the assessor establishes your property value each year as of January 2. However, you do not pay the taxes on that assessment until May 15 and October 15 of the following year. This delay provides taxpayers with opportunities to contest their assessments.
The notification process regarding your property taxes is governed by statute. The assessor must notify you of your assessed property value at least ten days before the initial meeting of your board of appeal and equalization—statutorily required to occur each year between April 1 and May 31. The duties of the local board of appeal and equalization are sometimes transferred to the county, in which case meetings will occur during the month of June. Prior to these meetings, an aggrieved taxpayer may apply to the local/county board for reduction in assessed value and will be offered an opportunity to be heard. This contesting of your taxes is often called an “administrative appeal.” Unfortunately, the assessor has no obligation to reduce any assessment through this process and it often results in little to no reduction. Many taxpayers simply bypass this process and file their appeal directly with the Minnesota Tax Court.
This alternative does not require the completion of the administrative appeal (i.e., no so-called “exhaustion of remedies”). The Minnesota Tax Court is a specialized court established by state legislature to hear appeals relating to issues of state taxation. There are three judges on the court, each of whom is appointed by the Governor for a six-year term. This court generally follows the same rules required in other state courts—such as the rules of evidence—and the judges issue decisions consistent with generally accepted appraisal methodologies and Minnesota statutes and case law. As a result, it is widely commented that an aggrieved taxpayer is much more likely to receive relief opting to appeal property tax assessments initially to the Minnesota Tax Court.
The deadline to file an appeal of your property tax assessment with the Minnesota Tax Court is April 30 of the year in which your taxes are due. Accordingly, the deadline to appeal your 2010 taxes—based on your January 2, 2009, assessment—is April 30, 2010. Because the appeal process is a legal process, and there are backlogs in many assessors’ offices and in the court itself, it can take more than a year to complete. During the appeal pendency you must continue to pay property taxes when due, although exceptions including a statutory 10 percent withholding remedy are available. If your case results in a value reduction, either through settlement or trial, you will be entitled to a refund of the taxes you overpaid, plus interest. Given the length of appeal processes, cases are also often resolved on multiple-year bases and often include resolution of assessments relating to taxes due in current/future years. This can be helpful in the budgeting process for anticipated fixed expenses—beneficial in these uncertain economic times.
Takeaway
If you are concerned that you are being overtaxed on your commercial property, you need to act before April 30, 2010. If you have questions regarding your assessed tax, please contact Fredrikson & Byron’s property tax group at (612) 492-7118 for a free analysis of your case.