A landmark ad valorem case recently won in Ohio emphasizes the role of valuation in providing support for an ad valorem tax reduction. The outcome of the case was momentous because it represented the first time the state of Ohio ruled favorably in an ad valorem case. Valuation specialists at Valuation Research were engaged to provide a valuation of the tangible assets of a manufacturing client. We were later commissioned to provide expert testimony when the ad valorem case was brought to court in Ohio. Before we discuss the specifics of the case, a primer on ad valorem is in order.

Characteristics Of Ad Valorem
The typical ad valorem candidate is one of the largest taxpayers in the tax jurisdiction and is paying a disproportionate tax burden. Ad valorem tax savings are immediate and may consist of a series of prior years that the taxpayer is contesting the tax. A valuation of the subject's property obtained from an independent valuation provider is critical to building an ad valorem case. Often, a company must enlist multiple valuation experts to provide business enterprise valuations, as well as personal property and real estate valuations.

In an ad valorem case, an element of functional or economic obsolescence usually exists. Functional obsolescence reflects the loss in property value due to changes in current technology, discovery of new materials and improved manufacturing processes. Economic obsolescence refers to the loss in value resulting from insufficient economic support, which means that there are insufficient earnings to support status quo aggregation of assets. Economic obsolescence is caused by external forces such as governmental laws, technological improvements, and changes in demand.

To determine whether or not economic obsolescence exists, a valuation professional values the components of a business enterprise, then ascertains if the sum of the parts is equal to the business enterprise value (BEV). If the sum of the parts exceeds the BEV, economic obsolescence is present. To determine the functional obsolescence that exists in the subject machinery and equipment, a valuation professional will identify any elements of undercapacity or overcapacity.

Valuation Approaches
Appraisals that conform to Uniform Standards of Professional Appraisal Practice (USPAP) and generally accepted valuation principles must consider all three approaches to value: the cost, market, and income approaches. The cost approach uses the concept of replacement as a value indicator, and is based upon the principle of substitution. This principle states that a prudent investor would pay no more for an asset than the amount for which he could replace the asset new. The replacement cost is then adjusted for losses in value (appraised depreciation) due to a variety of factors.

The market approach estimates value based on market prices in actual transactions. Use of this technique involves collecting market data for comparable assets and analyzing the consensus of the market. Adjustments are then made for comparability differences. The income approach capitalizes anticipated income streams associated with the assets being appraised. This approach is predicated upon cash flow or income projections, which are discounted for risk and the time value of money.

Ohio Case
The Ohio case emphasizes the role of valuation in providing support for ad valorem tax reductions. As mentioned previously, the case was a landmark decision because it was the first time an ad valorem case was won in the state of Ohio. We were engaged to provide valuations of the subject industrial property consisting of various manufacturing machinery and equipment located in two facilities. In addition, we appraised the business enterprise associated with the subject taxable assets.

Our analysis considered the history and nature of the business and the status of the industry and technology applied in the manufacture of the products of the company. The results of our investigation demonstrated that there has been a material decline in the industry as well as technological improvements that have significantly affected the profitability of the company. The valuation of the subject assets considered physical depreciation and economic and functional obsolescence. In this case, the extraordinary economic obsolescence was regarded as permanent and abnormal because it was determined that there were fundamental changes in the industry which would probably not be corrected over time. These changes would have a lasting effect on profitability.

Keys To A Successful Case
We recommend engaging an independent valuation expert to provide support for ad valorem cases. It is important to engage a qualified appraiser who holds the designation of accredited senior appraiser (ASA), and is skilled in expert testimony in case the valuation is later called into question. Our valuation staff is experienced in business enterprise valuations as well as real estate and personal property valuations and can provide multiple valuations when needed for ad valorem engagements. For more information, contact Bruce McCullum at (941) 637-1780 or Dick Nordberg at (414) 221-6220. VR