As property tax bills continue to rise, property owners are turning to us as tax professionals asking what they can possibly do to lower these costs. If someone owns an income-producing property, they may be especially dismayed to find that taxes are taking up a significant portion of that income—or they may have a newly-purchased property that is not yet making enough money to justify the hefty tax bill. A fairly straightforward strategy you can recommend is to appeal their property tax assessment.
Local governments rely on assessors to determine the value of each property in their tax jurisdiction. This value is then used to calculate how much is owed in property tax. Some areas do property valuations yearly and others every few years, but in either case, the details that go into a valuation can be surprisingly complex. Assessors are supposed to weigh a wide range of factors from the age and physical condition of the property to local rental rates and market conditions. However, key details can fall through the cracks, and this is where you have an opportunity to argue for a lower valuation on behalf of your client and increase their tax savings.
Today we are building upon our last blog, which focused on understanding how to make a case for a lower commercial property tax assessment. As a reminder, commercial properties include non-residential properties, such as warehouses, office buildings, medical offices, laboratory space, manufacturing plants, and similar properties that might be rented out to businesses, as well as apartment complexes with 5 or more units. To plan your property tax appeal, you will need to become familiar with the different valuation methods that are available.
How Property Tax is Calculated
You will first want to look into which valuation methods are considered acceptable in the locality you are dealing with, but there are generally five acceptable methods for calculating property tax. How do you know which valuation method to use? Simply put, you will identify the one that produces the lowest assessed value.
The available methods for calculating tax on a commercial property are:
- Fair Market Value Approach
- Cost Approach
- Commercial Equity Analysis Approach
- Income Approach
- Land Evaluation Approach
In this blog, we will cover the fair market value approach and a cost approach. These are the methods assessors are most likely to use, simply because they have the necessary data already available. However, as you are preparing your appeal, keep in mind that a less popular approach could give you a lower valuation—just confirm that this approach is allowed in your client’s area.
Fair Market Value Approach
In the fair market value approach, you are looking at similar properties that sold recently and using those prices to estimate a fair valuation for your property. The savings opportunity here is if you can argue that your valuation is higher than your property could realistically be sold for at this moment in time. Oftentimes, a high assessment can mean the assessor is still using the price you paid when you acquired the property, not its value today.
Property sales prices in your area might be dropping for a variety of reasons. If your neighborhood has become less popular, this can support your argument. Perhaps a new development has been built across town, drawing business away from your client’s property. The same case can be made if the property becomes less accessible, say because of construction on the roadway or because parking options have been eliminated. As long as the reason for devaluation is not caused by a change made by the property owner, you can argue for a lower tax assessment.
In your research, you will be looking for comparables that are similar in location, size, and age to your property. Three comparables is usually sufficient to make your case to the tax assessor or review board, so you will want to collect documentation showing the following for each comparable:
- Date of the analysis
- Property address
- Proximity to your property
- City
- Tax district
- Tax assessor parcel number
- Total appraised value
- Source of market sales data
- Date of sale
- Amount of sale
- Approximate appreciation per year
- Fair market value
You might also include the total square feet, the land appraised value, and the improvement appraised value if these numbers help to make your case.
To calculate the value of your property using this approach, you will take the total assessed value, and then you will calculate the cost of improvements. To get the improvement number, divide the appraised value of the improvement by the number of square feet of the improvement.
Cost Approach
The cost approach can be an effective method when the sales data for three or more comparable properties is unavailable. Instead of looking at what comparable properties are selling for (the fair market value approach), the cost approach estimates what it would cost to purchase a similar piece of land and construct a similar building on it, while also accounting for any depreciation factors relevant to your property. This is the most common approach used by assessors because the data needed is the most accessible. If you have a highly specialized business that has put in a lot of improvements to the property, your local assessor may have no idea how to value these improvements, so they will simply rely on the cost approach, which focuses on the cost per square foot for a property. Similarly, even if there are not many comparable properties in your area or there are not many recent sales, you can still collect the information needed to use the cost approach.
The formula for the cost approach is:
Replacement Cost + Land/Site Value – Depreciation Factors
So you are itemizing the different components of the building much like you would in cost segregation. The depreciation factors are going to be a primary source of savings here. The three main factors to consider are:
- Physical depreciation
- Economic obsolescence
- Functional obsolescence
Physical depreciation may be the most obvious factor. The building may be old or in need of repairs due to wear and tear. Anything that impacts the structural integrity of the building or might result in legally-required renovations can lower the valuation.
You can also consider the attractiveness of the building, the location of the building, or whether the building has any outdated features. This would fall under the category of economic obsolescence. Essentially, a newer or more attractive building is likely to be more profitable, so now we have a basis to argue for a lower valuation amount.
Lastly, functional obsolescence can apply to properties with unhelpful restrictions or less useful configurations. An older property might have a parking lot with narrow driving lanes and spaces that do not accommodate bigger SUVs and similar vehicles. You can actually apportion out the part of the price that relates to the parking lot and apply a different depreciation factor. Similarly, you could apply a different depreciation rate to basement level offices in a building since prospective tenants may not be as interested in renting there or may not be willing to pay as much in rent. Basement offices can even affect things like cellular service, making the experience less enjoyable for customers and other visitors. This can form the basis of a good argument for increasing my depreciation value on the square footage of that basement space.
Summary
Acceptable valuation methods may differ from area to area, but the fair market value approach and the cost value approach are the ones you will see the most often. If the locality you are working with allows different methods, take the time to evaluate which one will result in the lowest valuation. The time invested to do the research and calculate a new valuation will be well worth it when you can present the potential tax savings to your client.
To learn more about more strategies to help commercial property owners save on their taxes, become a Certified Tax Planner today.
