PROPERTY TAXES ARE ONE OF THE BIGGEST expenses for a manufacturing company. However, unlike corporate income taxes, property taxes may not decline in a slumping economy. In fact, they actually may continue to grow. This is due to the manner in which assessors determine property taxes for industrial property. A savvy owner of industrial property can make lemonade out of lemons by proving economic obsolescence due to worsening market factors that have reduced the market value of the owner's industrial property. The result can be sizeable tax refunds.
How assessors determine value
A manufacturing facility is a complex property consisting of land, buildings and structures, machinery and equipment, and other personal property. Rather than attempting to capitalize income or rely upon sales of comparable industrial facilities, it is much easier for assessors to rely upon the trended investment — also called the historical cost approach — for determining the market value of industrial property.
To arrive at market value by the trended investment or historical cost approach, the assessor first adds up the original historical cost of the individual assets comprising the industrial property. Second, the assessor trends it to current cost by a consumer price inflation factor and by depreciating the trended cost. By this method, the assessor can easily calculate the assessed value of a complex industrial property annually without ever setting foot on the property.
Unfortunately, this cost approach overvalues industrial property. First, technological advances have reduced the costs for machinery and equipment. Computers and computerized controls are prime examples. Second, cost does not necessarily equate to market value. Costs to refurbish or upgrade machinery and equipment may simply allow the manufacturing process to continue without any increase in production. Third, the trended investment approach looks at costs incurred and expended over the past several years or decades, when the economic climate was much different.
Plummeting market value
Economic or external obsolescence is defined as the loss in value or usefulness of a property caused by factors external to the property, such as increased cost of raw materials, labor or utilities (without an offsetting increase in product price). Reduced demand for the product, increased competition, environmental or other regulations, and inflation or high interest rates are other factors that can lead to economic obsolescence. These scenarios have caused the market value of industrial property to plummet in a number of industries over the last decade:
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The Oregon Department of Revenue has reduced the value of sawmills by 40% based on economic obsolescence caused by regulations to protect the spotted owl, which have resulted in prohibitions on logging the federal forests.
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An oversupply of semiconductor computer chips beginning in 1998 severely reduced or eliminated profit margins for industrial plants producing chips.
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High energy prices have closed aluminum smelters.
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The flood of fresh vegetables and fruit from Mexico, Central America and South America following the enactment of the North American Free Trade Agreement (NAFTA) caused the prices of canned and frozen vegetables and fruit to plummet, leading to the closure of Northwest U.S. food processing plants.
The benefit of presenting proof
All of these are examples of economic obsolescence reducing the market value of real and tangible personal industrial property. In each of these instances, substantial property tax reductions were obtained and significant tax refunds issued.
Industrial owners can measure economic obsolescence by graphing the historic decline in gross profit margins at a plant or showing that the amount of production is declining as a percentage of capacity. (Please see chart above for tips on how to prove obsolescence)
By presenting this kind of proof to assessors and state Departments of Revenue, industrial taxpayers have received refunds of hundreds of thousands of dollars because the assessing authorities were forced to recognize this one simple fact: The market value of industrial property had been reduced by a significant amount due to economic obsolescence.
David L. Canary is an owner in the Portland, Ore., law firm of Garvey, Schubert & Barer and the Oregon, Washington, Montana and Idaho member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.
HOW TO PROVE ECONOMIC OBSOLESCENCE
- Chart the historic decline in gross profit margins.
- Show the decline in the number of operating plants in an industry over the last five years.
- Show that the amount of production is declining as a percentage of capacity.
- Compare assessed values of manufacturing plants in the same industry with their sale or liquidation price.