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Property tax is one of the biggest tax expenses companies have -- and the hardest to manage.
Tim Reason, CFO Magazine
February 1, 2004
For all the ire directed at state income and sales taxes, companies largely ignore the largest levy they pay—property tax. According to the Council on State Taxation, in Washington, D.C., American companies fork out more in property taxes than in any other type of state or local tax.
In fact, corporate taxes are becoming increasingly localized. At the federal level, both the amount paid by companies and the percentage of total federal government revenue it represents have declined. At the state level, total corporate income tax has more than doubled since 1980, but has fallen dramatically as a percentage of state and local taxes. Taxes on business property, meanwhile, jumped to $153.1 billion, or 38.3 percent of all non-federal taxes companies paid (see "The Biggest Slice" at the end of this article).
Yet because property taxes are generally promulgated by thousands of jurisdictions, companies often do a poor job of coordinating them. Even in corporations with centralized finance and tax functions, property-tax issues often end up on the plate of regional controllers, not tax specialists. The bottom line: one of the largest tax expenses many companies face is also one of the worst managed.
A Fixed Cost?
Of course, the best time for a company to handle property taxes is before it moves to a new location. Yet even when states offer property-tax abatements as relocation or expansion incentives, companies tend to leave money on the table, says Tammy Propst, partner in charge of KPMG LLP's strategic relocation and expansion services practice. And companies know this. A September survey of tax and real-estate professionals conducted by KPMG found that property-tax reductions ranked number one in importance among local, state, and federal tax incentives and credits. Yet when it came to the incentives actually offered, job-creation tax credits and sales-tax exemptions were used more frequently than property-tax abatements.
It's bad enough that companies do a poor job of securing the lowest-possible taxes when they move to a new location. But once a company is actually installed somewhere, property taxes tend to be treated like a fixed cost. After all, companies cannot take advantage of the sorts of nexus issues that help them reduce sales or income taxes.
For Mack-Cali Realty Corp., a Cranford, New Jersey-based real-estate investment trust, real-estate taxes and utilities are the two largest operating costs. CFO Barry Lefkowitz says property tax is "not the place where there is a lot of tax planning to be had—and you don't get to take deductions for losses or depreciation." Still, he says, there are steps that businesses can take to manage property taxes.
Property tax should not be considered a fixed cost or dismissed as a potential source of savings, agrees Stuart Rosow, an attorney with New York-based Proskauer Rose LLP, who helps corporations deal with tax issues related to mergers and acquisitions. "One of the biggest money-savers for us is a property-tax reduction," says Rosow, who recently helped a corporate client reduce the state and local property taxes on an acquisition that, he says, had overvalued its real estate, factory buildings, and equipment.
Such big savings don't come easily. "For a CFO or a tax manager, [managing] property tax is incredibly intensive. It is not as easy as dealing with the [Internal Revenue Service]," says Rosow. "I clash with the [IRS] all the time—but in all fairness, at...the IRS, you tend to deal with bright people who understand the law, and you get to a reasonable result." That's not necessarily the case when working on property-tax issues at the local level, he says. "Dealing at the local level can get dicey."
Still, he notes, "there are a number of very good consultants [who can help reduce local taxes], and a lot of them will work entirely or largely on a contingency basis." There are also attorneys—known as certiorari, or property-tax protest attorneys—who provide such services. Given the local nature of property taxation, some form of outside help is typically necessary for nationwide companies. For them, the trick is managing the effort, since even the largest tend to be regional.
Is That a Fair Value?
Most finance executives don't think in terms of property tax. Actual property-tax liability bears even less correlation to the numbers reported on corporate financial statements than federal income-tax liability. That's because generally accepted accounting principles in the United States require companies to value property at an amortized historic cost. Property taxes, by contrast, are based on fair-market value. And, as every property owner knows, those values can vary depending on who is doing the calculation.
Likewise, says Lefkowitz, local assessors often rely on recent sales and leasing activities to estimate the value of similar properties, although they may also retreat to stronger market periods to retrieve higher lease and sales levels, which skew values to a higher level. Similarly, an office building that has a single tenant with a 10-year "triple-net" lease—meaning the tenant manages the building and pays all operating and maintenance expenses, property taxes, and insurance—can badly skew the assessment of similarly sized multitenant buildings. "The single-tenant building would sell for a lower capitalization rate of 100 to 200 basis points, thereby creating a more-valuable asset vis-à-vis a multitenant building with shorter-term, gross leases," says Lefkowitz. Such differences, he says, should be pointed out to an assessor—ideally before the new assessment is published.
That isn't always possible. A recent scandal in New York has led to a prohibition on contact between assessors and taxpayers until after assessments have been published. And for national corporations, maintaining a relationship with local assessors is a task that almost always has to be handled at a local office or by a local consultant. "You can't just hire any old accountant," notes Carolyn Makuen, state and local tax specialist for Geller & Co., a New York-based finance, accounting, and tax outsourcing firm. "Typically, you have to hire someone who is a former assessor. Property tax is a very insular, byzantine, and specialized area."
Of course, says Barry Gosin, CEO of New York-based Newmark & Co. Real Estate Inc., property owners "have a legal right to be treated fairly. If you are overtaxed and can demonstrate it, the municipality has a legal obligation to reduce your taxes." Still, he warns, companies shouldn't mess with taxation authorities unless they have a clear case: "Sometimes you don't want to open up Pandora's box. You may open yourself up to increases, too."
Tim Reason is a senior writer at CFO.
Business Tax Balance
One protection that businesses have traditionally had against property-tax increases is that they generally affect homeowners—read: voters—as well as commercial owners. But the interests of homeowners and businesses may be diverging in the current economy. While home prices have continued to stay strong in many parts of the country, commercial values have fallen. That, in turn, may put pressure on more municipalities to institute split rates.
Last October, the California Teachers Association announced it would propose a constitutional amendment on the state's November ballot to raise the rate of business-property taxes to 1.55 percent of assessed value. California has long been famous for Proposition 13, which froze both individual- and business-property taxes at 1 percent of assessed value. Gov. Arnold Schwarzenegger opposes the initiative, says spokesman H.D. Palmer.
But Schwarzenegger also faces a quandary because the limits imposed on property taxes by Proposition 13 have long made local governments in California dependent on Sacramento for funds. By making good on his campaign promise to cut predecessor Gray Davis's hated car tax—which was used as a source of funding to local governments—the new governor eliminated the primary source of funds for local government (and voter) priorities such as policing and schools. In Massachusetts, meanwhile, where housing prices are among the highest in the country, an effort is under way to raise the allowed levy on commercial property from 175 percent to 200 percent of the residential-property levy. Without that change, residential taxpayers in Boston may shoulder as much as $100 million in taxes once paid by business.
Renters Pay Taxes, Too
Many corporations, of course, own little or no property. But just because a company rents its office space doesn't mean that property tax shouldn't be considered. In the Northeast, for example, property taxes range from 15 to 25 percent of the total rent, says Barry Gosin, CEO of Newmark & Co. Real Estate Inc., in New York.
"When they negotiate leases, CFOs should think about how the structure of the lease will affect the taxes on the building," explains Gosin. For example, the cost of major renovations or alterations made at the request of an incoming tenant is often amortized through the rent—particularly if the landlord borrowed to fund the work. But that can inadvertently increase property taxes, he warns.
"The taxing authorities assess buildings based on income stream, without consideration of [the landlord's] debt," explains Gosin. It is often better, he suggests, for a company to negotiate rent for the property "as is," and work out some form of third-party financing for the renovations. "Tenants don't want to use their capital," he notes, "but they have to balance that [against the fact that] higher rent could have an impact on their taxes."
About 65 percent of Newmark's business comes from representing large corporations in lease transactions, says Gosin. "There are many subtleties to structuring leases, and every principality is different."
Moreover, says Gosin, large corporate tenants should make sure that the lease requires the landlord to initiate a tax certiorari (or property-tax protest) proceeding at the tenant's request. "Companies should obligate the landlord to go to the mat," he says. While large corporate tenants can certainly be the backseat drivers in such proceedings, privity—ownership of the property and a direct relationship with the taxing authority—makes it easier from a logistical and legal point of view for the landlord to take the lead role.