Every year, property professionals attend The Counselors of Real Estate (CRE) convention. Over 25 Counselors attended the meeting of state and local tax (SALT) professionals in Nashville to learn and discuss the latest challenges that taxpayers face in local and state property tax laws.
One theme that resounded loud and clear at this year’s SALT discussion on property tax issues was the growing demand for property tax reform by both taxpayers and property tax professionals, including attorneys, appraisers, and consultants. At the outset, participants acknowledged their discontent with the entire concept and process of property tax administration.
The discontent is a result of the inconsistency in the execution of state law by local taxing jurisdictions. It was the consensus of the SALT special interest group that there are fundamental disconnects that are materializing to a much higher level of concern than ever before. This issue has escalated to the point where there is now an active push for increased transparency around real estate property taxes.
So, what are the fundamental disconnects that are driving property tax reform? Read on to find out.
The Burden on Government Officials to Protect Tax Revenues
Since the recession in 2008, many local and state governments have been facing fiscal pressures attributed to a rapidly retiring workforce, shifting demographics, unionized workforces, and a large public sector labor base.
Given that property taxes are the major source of revenue for local and state governments’ operating budgets, many assessors have adopted aggressive property assessment practices. In turn, this has spurred a slew of new valuation concepts and models that are causing mass confusion for the public and the courts.
For example, the Elkhart County, Indiana Assessor commissioned a study by a consultant to address the Assessor’s assertion that the assessments of industrial properties are below market value. This means that the value of the property is based on its ability to produce revenue or utility for a particular use, which is contrary to most state laws that require assessments based on market value.
Market value is generally defined as the most probable price, estimated in terms of money, that a property can bring in a sale between a willing buyer and seller under arms-length conditions in an open market with adequate market exposure and reasonable marketing time. The consultant generally concluded that the valuations of new properties were assessed at market value while the valuations of older industrial properties were below market.
His recommendation was to extend the economic life for industrial buildings from 35 years to 60. In addition to other conflicts of this arbitrary change in economic life, this resulted in the assessed value of industrial properties to substantially increase, some by as much as 33%. The taxpayers are now waiting for their day in court.
And this is not the only instance of this behavior. Many tax assessors are also leveraging the use of commercial mortgage-backed securities (CMBS) data, that must be made public per the Dodd-Frank Act, to support their current tax rolls. CMBS data values the “leased fee interest,” which is the value of the contract rent over an appropriate holding period. In contrast, state laws generally require assessor to deliver property tax assessments based on the fee simple market value as of the lien date.
Although state law is fairly consistent throughout the U.S. in defining taxable interests as “fair market value” or “fair value" of the fee simple interest, some jurisdictions and courts have flipped this concept on its head. They have introduced, and in some cases accepted, new definitions to describe the taxable interest such as the “leased fee interest” or “value in use” as equivalent to the fee simple interest.
Mounting Pressure on Property Taxes to Fund Pension Programs
A significant issue that has been partly responsible for 69 municipalities filing for Chapter 9 bankruptcy since 2010 is underfunded pensions and healthcare benefits promised to current and future local government retirees, a practice adopted by local governments decades ago.
Such was the case in Springfield, Illinois, where 100% of the 2018 property tax revenue collected went to the underfunded pension fund with no revenue available for the jurisdiction’s operating budget. The issue stems from the inability of property tax revenues to keep up with the rate of pension payment increases.
As a result, the local municipality is facing the real issue of cutting back on services and the size of its government workforce, which directly impacts the economic viability of the community. These actions then create a cycle of disenfranchisement as people leave the community for better opportunities and quality of life, shrinking the tax base available to meet pension funding obligations.
However, this is not a situation specific to the city of Springfield, and it’s indicative of what local governments are experiencing nationally. For example, between 2010 and 2018, five cities saw a 10% net decline in property tax revenues.
Corporate Exodus from High Tax States
While a corporate press release will never state that a corporation is moving its headquarters or manufacturing operations to another state with lower property taxes, it is generally in the mix.
Take Connecticut, for example, which ranks number one in the country for having high property taxes.
In 2018, Bristol Meyers Squib announced that they were moving their research and development operations out of Connecticut. They attributed their move to corporate restructuring. But what they failed to mention is their settlement of a property tax appeal, which delivered mediocre savings and confirmed the town’s focus on protecting the roll rather than working with their largest employer and taxpayer.
Bristol Meyers Squib had alleged that the property tax assessment was excessive and did not correctly reflect the value of the property, which had dropped by $13.5 million. And Bristol and Meyers Squib is not the only one. Aetna and General Electric, both legacy companies in Connecticut, left the state soon after.
When states are known for their high property taxes, they negatively impact their economics, as no corporation will even consider these states as potential locations. Another result of corporate flight shows up in the resale of these former corporate locations, which return pennies on the dollar when compared to the assessments.
Taxpayers Seeking Tax Reform
Taxpayers on the local level are also trying to change the property tax system to make it fairer to all taxpayers. The state of California is a leading example of how constituents are using their voices to enforce property tax reform, with the inclusion of the split roll proposal on the November 2020 ballot.
The California spilt roll proposition leaves Proposition 13 in place for residential and small businesses whose tax assessment is based on the property’s purchase price with a 2% cap on increases in value. For all other commercial and industrial owners, Proposition 13 would be eliminated, and reassessments would be made annually based on the fair market value using the accepted valuation methodology.
This sweeping reform impacts the assessors the most, and they have been vocal about the additional manpower that would be required to implement and administer the split roll assessments. However, it is a step in the right direction in advocating for more transparency when it comes to real estate property taxes that impact not just corporations, but small mom and pop stores and homeowners as well.
What’s the Solution?
The consensus of the Counselors SALT group called for more vocal transparency around property tax laws, both in our daily practices and escalating the conversation to the local and state level. By leveraging the individual voices and collective expertise of industry professionals, true property tax reform can be achieved.