Valuations Offer Support for Ad Valorem Tax Savings

In 2013, property taxes on real and personal property owned or leased by businesses accounted for the largest share of total state and local business taxes in the U.S. These taxes amounted to $228.7 billion or more than 35%. Conversely, corporate income taxes accounted for just 7.6%.

Property taxes are local government’s main source of revenue for schools, police and fire departments, libraries and other local services. Property taxes are computed by multiplying a property’s assessed value (AV) as formulated by the local assessor by the local tax rates. The primary factors affecting AV are:

  • size
  • condition
  • utility
  • location
  • age
  • economic and market forces
  • future capital costs

While assessed values may not be changing, the reality is that tax rates are increasing. This can be seen in this simple equation:

Tax Rate = Cost of Government / Total Value of Property

If values drop and government costs remain constant or continue to grow, then tax rates increase. So, even though a company’s taxable value may be decreasing, the company’s tax will increase because the tax rate is increasing. Therefore, real and personal property taxes are important for many companies to assess and understand in order to contain them.

Characteristics of Ad Valorem

Typically the largest taxpayers in a tax jurisdiction are paying a disproportionate tax burden. If an appeal is warranted, property tax savings can be immediate and may even include prior year appeals. A valuation of the property in question, obtained from an independent valuation provider, is critical to building an ad valorem case. To do this, a company may need to enlist multiple valuation experts to provide business enterprise valuations, personal property and real estate valuations.

When deriving fair market value (for real or personal property), an element of functional or economic obsolescence usually exists. Functional obsolescence can reflect the loss in property value due to changes in current technology, discovery of new materials, or improved manufacturing processes. Economic obsolescence refers to the loss in value resulting from insufficient economic support that leads to insufficient earnings to support a status quo aggregation of assets. Economic obsolescence is caused by external forces such as governmental laws, technological improvements, or 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 if functional obsolescence exists, a valuation professional will identify elements of under capacity or overcapacity in the subject’s machinery and equipment.

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 implies that a prudent investor would pay no more for an asset than the amount 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.

Property tax analysis considers the history and nature of a business, the status of the industry, and technology applied in the manufacturing of products for a company. The results could demonstrate that there has been a material decline in the industry as well as technological improvements that have significantly affected the overall profitability of a company. The valuation of the assets considers their physical depreciation and economic and functional obsolescence. In many cases, extraordinary economic obsolescence can be regarded as permanent and abnormal because it has been determined that fundamental changes in an industry would probably not be corrected over time. These changes would have a lasting effect on overall 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 your VRC representative.