(Estimated reading time: 3 minutes 8 seconds)
The article in brief:
- Companies that can accurately distinguish between real property and personal property may be able to minimize their property tax liability.
- Companies with significant manufacturing facilities often overlook this exercise, which may have a substantial impact on taxes.
- The process of distinguishing between real and personal property involves applying a relatively simple three-part test, but case law and state-level nuances also must be considered.
Almost every piece of property falls into one of two categories: real or personal.
What is the difference between real property and personal property?
Real property is generally deemed as buildings, improvements, fixtures, and the rights or privileges associated with the land. While, personal property consists of all goods, wares, merchandise, chattels (i.e., tangible movable property, such as tanks, overhead cranes, or furniture), and effects that have marketable value and are not included in real property.
While the definitions of property seem straightforward, there is considerable room for interpretation of the dividing line between tangible personal property and real property that may have a significant economic impact for taxpayers.
Why Does Classification of Real and Personal Property Matter?
The distinction between real and personal property can apply in a variety of different contexts. Certain issues may arise when a creditor would like to take possession of a piece of equipment that may be integrated into the real estate or possible disputes regarding which items a seller can remove when they vacate a property. In the property tax context, the issue relates to the taxation of property as either real or as personal property.
While U.S. states have historically taxed all tangible property, many of them, especially Rust Belt states hoping to attract new investment and retain existing manufacturing, have eliminated or are phasing out tax on personal property. Thus, the ability to properly categorize property as ‘real’ or ‘personal’ often can reduce the overall tax burden.
Recategorization of certain assets can have other tax benefits too—filers can generally depreciate short-lived personal property more quickly than long-lived real estate assets. In some cases, the categorization process can reveal instances where property has inadvertently omitted from taxation, or worse, taxed twice by the local jurisdiction.
The reexamination of the categorization of real and personal property can often be a worthwhile exercise for property owners interested in materially reducing their tax liability.
Fixtures and the Three-part Test
When it comes to classifying property as real or personal, most of the time the correct classification is readily apparent; however, a gray area lies within the determination of what constitutes a fixture.
Fixtures are defined as articles that were once personal property but have been installed or attached to the land or building in a somewhat permanent manner. They are legally regarded as part of the real estate and, thus, deemed real property.
In determining whether an item should be classified as a fixture for tax purposes, most taxing jurisdictions typically apply a three-part test which was born out of Teaff v. Hewitt, 1 Ohio St. 511, 529-30 (1853), a mid-Nineteenth Century legal case which serves as the basis for the “common law” determination of fixtures associated with real estate. Under this framework, most states consider:
- Annexation/Attachment—an evaluation of how the property has been connected to the real estate, how it might be removed and how much damage removal might cause
- Adaptation—how the property in question is used in relation to the real estate
- Intent—is the property intended to be permanently affixed to the real estate or does change of highest or best use of the real estate change the intent of the fixture
Varied Jurisdictional Issues and Approaches
No bright-line rule exists to define what constitutes a fixture. The aforementioned three-part test derived from Teaff v. Hewitt is foundational for determining whether certain property is or is not a fixture. However, in the subsequent century-and-a-half since the case was decided, states, localities, and the courts have created complex—and in some cases contradictory—edifices of statutes, ordinances, and precedents for which the correct classification of property can be debatable. Taxpayers face significant taxation issues due to the ambiguity of the determination of fixtures and irregular application of common law tests in various contexts, as evidenced by the following excerpt from a recent US District Court decision:
“What complicates the inquiry is that the governing state law principles derive from dated and, at times, inconsistent case law. In some instances, courts have relied on certain criteria in holding that an item was a fixture, while on other occasions, different criteria have proved decisive.” (Source: FirstMerit Bank, N.A. v. Antioch Bowling Lanes, Inc. 2015 U.S. Dist. LEXIS 72872 (N.D. I11.2015))
The reexamination of the categorization of real and personal property can often be a worthwhile exercise for property owners interested in materially reducing their tax liability. However, the lack of a distinct definition of a fixture and the grey area surrounding the delineation of real vs. personal property suggests the taxpayer become knowledgeable of relevant local case law and historical assessment practices, or seek advice from an experienced tax advisor and/or valuation professional to assess their property tax position.
Property owners embarking on such an exercise should work with a qualified expert to craft a proactive strategy, including a benefit analysis, and be prepared to provide evidence—potentially including testimony of plant engineers and personnel—to support their position.
VRC’s real estate and machinery & equipment valuation teams are comprised of senior professionals ranging from 10 to 40+ years of industry experience. We have completed thousands of engagements ranging from single location to multi-thousand plus properties, including individual assignments exceeding $10 billion in value. To discuss your real and personal property valuation needs, we invite you contact article author, Ryan Werkheiser, or any VRC professional nearest you.
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