The property tax bills of commercial property owners can be significantly reduced by the exclusion of “intangibles.” But many commercial property owners have little knowledge of what intangibles are, why they are important, how to segregate them from other assets, and what action they can take to keep intangibles from being included in property tax bills.

Property owners hold both tangible personal property assets (such as computers, desks, equipment, etc.) and tangible real property assets (such as land and buildings). Intangibles may be described as “non-physical” personal property assets that have a value. Even though the asset's existence is represented by a document, its value is not based on its physical attributes.

Business records, goodwill, trade secrets, customer lists, patents, trademarks and copyrights, a permit for a landfill, a franchise affiliation for a hotel, a trained and assembled workforce, and the trade name of a department store are some examples of intangible personal property assets.

Segregation Is Key

Two factors point to the importance of intangible personal property. First, the intangibles may represent more value to an owner than the real estate or tangible personal property. For example, the owner of an otherwise useless piece of real estate may create a great deal of value in that land if a landfill permit is obtained. The true value is in the permit, not in the land.

Second, most states don't subject intangibles to property tax assessments. Local assessors in all states can assess real property, in most states they can assess tangible personal property, but in very few states can they assess intangibles. Thus, the importance of segregating these non-taxable intangibles becomes abundantly clear.

This segregation is especially important in determining businesses' “going concern” value, which consists of three components: real estate, personal property and intangible property. Examples of businesses that rely on this type of valuation include hotels, restaurants, nursing homes, bowling alleys and regional malls.

Since assessors value these and most other commercial property types by utilizing an income approach to property valuation — in which a property's value is based on its ability to maintain a stream of income — owners must identify and segregate the components of the income stream that can be attributed to intangibles.

For example, assume a McDonald's restaurant produces annual revenues of $1 million. Across the street in an identical building, Joe's Hamburgers, produces revenue of $500,000. In that case, the intangible franchise (the McDonald's trade name) may be as valuable as the real estate. If the local assessor's office utilizes the $1 million income for McDonald's in its formula, McDonald's taxable real estate will be grossly overvalued because the assessor will have included the intangible value related to the McDonald's franchise.

To illustrate the point using a different industry, consider this hotel example: Two physically identical hotels in the same location produce different revenue because one is affiliated with a national chain and the other is independent. The revenue attributable to the intangible franchise affiliation should be segregated from the revenue produced by the real estate.

Significant Savings

The segregation of intangibles and their elimination from the assessor's valuation formula reduces the property tax burden on various types of property. Recently, a judge reduced the value of a four-building conference center complex in Loudoun County, Va., by more than $15 million because the taxpayer segregated the value of its intangibles. The value of that property was due in part to the conference center business. The taxable real estate formed a part, but not all, of the going concern.

Business start-up costs, favorable contracts and an assembled workforce, with expertise in the conference center business, generated a portion of the income produced. The income attributable to these intangibles was eliminated from the formula used to determine the value of the taxable real estate, resulting in the reduction of more than $15 million.

In another recent case, the value of a hotel was reduced 40% by the segregation of intangibles. The taxpayer was able to prove how much of the hotel's revenue stream came from intangibles such as an assembled and trained workforce and the brand name of the hotel. By segregating the intangible portion of the revenue stream, the taxpayer received a lower assessment.

Once a commercial property owner grasps the concept of intangibles and identifies them, the biggest challenge is quantifying their value. This may require the expertise of a qualified appraiser, but commercial property owners who do not pay the price to understand and identify intangibles may pay a bigger price to the local taxing jurisdiction.

Andrew Raines is a partner in the law firm of Stokes Bartholomew Evans & Petree, P.A., the Arkansas, Mississippi and Tennessee member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.