The foundation for a property tax appeal rests on an analysis of the property's value for real estate tax purposes. The valuation analysis can be based on numerous comparisons, the most important of which is the comparison of market price to sale price. The analysis also must include the property's ability to generate revenue.

This valuation analysis provides the first clue regarding whether the assessor's valuation of a property is equitable. Market value is most often defined as the probable price a willing buyer would pay a willing seller in the open market. It implies that the property has been on the market for a reasonable length of time, and that both buyer and seller know the present and potential use of the property.

The sale price at which a property sells does not necessarily reflect market value for property tax purposes. For example, a developer probably pays more than market value for parcels needed for a site being assembled to build a shopping center. On the other hand, a seller needing cash in a hurry probably sells at below market price.

Further, in most cases the sale price includes more than just the tangible real estate. Non-real estate value components, such as personal property (furniture, fixtures, equipment and inventory), contract rights, brand name, patents, copyrights, an assembled work force, special financing and business enterprise value are included in the sale price. Non-real estate elements have no place in the formulation of a property tax assessment.

Owners need to closely scrutinize all of the components of the sale price as well as the motivation behind the sale to determine whether the sale price is equal to the property's value for real estate tax purposes.

Market rent vs. contract rent

The buyer of a single-family home makes the purchase to enjoy the benefits that the property will afford in the future. Likewise, the buyer of an investment property pays the purchase price in order to receive future benefits — the annual income stream generated in rents.

In making decisions about buying or selling a property, investors, the typical owners of income-producing property, rely primarily on the property's ability to produce income. Analyzing the property's income potential can determine if the property tax assessment is fair.

Of the various types of rents, taxing authorities usually base their property tax assessments on either market rent or contract rent.

Market rent is the rate justified for a property based on what owners of comparable properties in the area charge to rent their space. With certain exceptions, property tax assessments are generally determined based on market rent.

However, the assessor may use contract rents as the basis for tax assessments. Contract rent represents the rent payments required of a tenant under the terms of a lease. Often, market rent and contract rent calculations arrive at the same number, but where contract rent is less than market rent, property tax value is affected. So, depending on whether the assessor uses market or contract rent as the basis for determining a property tax assessment, an owner can pay more or less tax.

Real-life applications

Let's say a tenant signs a lease agreeing to pay $5 per sq. ft. for office space that rents on the open market for $10 per sq. ft. If the property tax assessment is determined based on the $5 per sq. ft. contract rent, the property generates less revenue, and therefore has less value, than if the assessment is determined based on the $10 per sq. ft. market rent.

Consequently, if the taxing authority bases the assessment on market rent, the contract rent supports a lower assessment than market rent. In such a case, a property tax appeal may well be successful.

Owners must understand whether the law requires taxing jurisdictions to value property based on market rent or contract rent, and whether the owners' property is charging a market rent. With this information, an appropriate decision can be reached concerning the appeal of the assessment.

Before making a final decision to appeal a property tax assessment, it may be useful for the owner to obtain a property tax appraisal to help verify the property's value for tax purposes.

Failing to understand what constitutes value from a property tax point of view results in high property taxes.

Vickie Norman is counsel at Baker & Daniels in Indianapolis, the Indiana member of the American Property Tax Counsel. The APTC is the national affiliation of property tax attorneys.