Perhaps the most significant current controversy in property tax law is the dispute between taxpayers and tax authorities over the existence, quantification and allocation of business value vs. tangible real and business personal property value of a going concern. This controversy arises because intangible property (business value) is generally exempt from property taxation and real and business tangible personal property is taxable.
Business enterprise value is a value enhancement to a going concern (th e latter of which consists of real property, personal property and business enterprise value) that results from intangible personal property such as marketing and management skill, an assembled work force, working capital, trade names, franchises, patents, trademarks, non-realty related contracts and operating agreements. In contrast, only value directly attributable to the physical characteristics of the real or personal property is tangible and therefore taxable. The business enterprise value issue has arisen in property tax disputes involving various types of real and personal property such as shopping malls, hotels, health care facilities, telecommunication systems, golf courses and land-fills. However, court opinions and journal articles have provided little guidance.
Thus, the process of identifying and valuing the different components of a going concern in order to separate the taxable and non-taxable items is refined continually by lawyers, appraisers and the courts. The following discussion presents a basic framework that was successful in a recent jury trial involving hotel property tax. This framework involves a two-step process. The first is to understand the issues as fully as possible. The second is presenting the issues in a way that is understandable, credible and convincing.
The 1997 annual seminar of the American Property Tax Counsel (APTC), the national affiliation of property tax attorneys, explored these issues in a program devoted to hotel valuation. (See NREI, January 1999 Tax Notes for a discussion of REIT valuation). APTC members selected as the preeminent property tax counsel in their states and numerous leaders in the hospitality industry participated in the seminar.
Drawing upon the wealth of knowledge and experience represented at the seminar, plus its own experience in the field, the Texas APTC affiliate recently obtained a $29 million reduction in value in a jury trial for a major flag hotel. The success was possible through a thorough knowledge of the principles of hotel valuation and the assembling and effective utilization of knowledgeable experts.
The hotel's case consisted of expert testimony from a MAI value appraiser, a hospitality industry expert, an MAI value theory and ethics appraiser and a witness from the hotel company.
The valuation expert relied most heavily on the Income Approach. The market value for the subject property was subdivided into three components by subtracting the income/expenses attributable to each from the overall income stream of the property: real property (land and improvements); tangible personal property (furniture, fixtures and equipment); and business value (intangible personal property).
The appraiser determined the market income by establishing the average occupancy and daily rates of the competition in the immediate market. This adjustment to the actual historical income stream accounted for any income attributable solely to the flag of the hotel in comparison to the competition. The appraiser then extracted the remaining business value by deducting from the 'de-flagged' income stream any income attributable to management, franchise fees and start-up costs. This left income attributable to real property and tangible personal property.
The income attributable to personal property was established by determining the income associated with recapture of replacement cost and return on investment of the personal property. The resulting net operating income estimate was capitalized to determine the value of the real estate.
The jury found the testimony of the non-valuation experts particularly enlightening. The MAI appraiser offered supporting testimony on methodology, industry standards and ethics in appraising and reporting; the hospitality expert offered supporting testimony about the creation and existence of business value; and the hotel witness offered a practical insight into the operation of a hotel.
This case represents one of the few successful trials involving the business value of a major flag hotel. It dramatically highlights the importance of a thorough knowledge of the issues coupled with effective utilization and presentation of expert testimony.