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Property taxes are one of the largest expense items that owners of complex properties such as manufacturing, refining, communication, transportation and utility companies face. Unfortunately, industrial plants are routinely overassessed for ad valorem tax purposes due to assessors’ heavy reliance on the cost approach to value.

The cost approach considers the price to replace the real and personal property assets with a modern equivalent. Deductions are made for losses in value due to physical depreciation, functional obsolescence and other external causes. Each of these deductions relies on opinion. Consequently, they can be a subject for negotiation by the taxpayer.

Overstated RCN

For many complex industrial properties, there are few new plants to study in order to determine what the replacement cost new (RCN) should be. Construction is often limited due to high labor costs, local resistance to industrial development and the difficulty in obtaining permits resulting from environmental concerns, endangered species, etc.

The global economy and trends toward the development of manufacturing in lower-cost countries also plays a role. The proximity to market, location of raw materials, transportation and opportunity for incentives are major factors that impact where complex property investment will occur.

As a default, the assessor or appraiser must rely on the taxpayer’s property tax rendition. Usually the historical installed costs by year of acquisition are trended, in order to estimate the current replacement cost. This type of estimate can be misleading for a number of reasons, including technological advances and innovation such as computer controls, robotics, energy efficiency, etc., which may result in a cheaper cost to acquire and offer more performance.

More importantly, cost does not necessarily equal market value. The price paid to upgrade machinery may simply allow the process to continue without an increase in productive capacity.

Unsupportable Floor Values

Given the emphasis on the cost approach, many assessors and appraisers have differing opinions regarding the economic lives of industrial properties and the residual values of various component assets.

They usually apply published depreciation tables based upon the estimated economic life to determine the percent good as an estimate of current value. These tables are general in nature and only consider physical depreciation from “normal” wear over the estimated economic life. The application of arbitrary trend and depreciation factors often results in an unsupportable “floor value” that is not linked to market reality.

The cost approach considers that an asset will have a residual value at the end of its economic life, even if it’s represented by a scrap or liquidation value. However, there are many cost components that have no residual floor value. This includes:

• Self-constructed machinery & equipment

• Capitalized labor

• Proprietary processes

• Installation costs

• Sales & use taxes

• Transportation & delivery fees

Obsolescence

Functional obsolescence is a loss in value that may be caused by a deficiency or a super adequacy. For instance, if a taxpayer’s manufacturing plant were built today, a higher ceiling height might be required. This would necessitate a deduction.

Factors external to the property can also impact value in the form of economic obsolescence. Examples include reduced demand for the product, increased competition, inflation, high interest rates and regulatory demands.

The impact of obsolescence on the value of complex property can be considerable and is something that must be evaluated on an annual basis.

For the Record

Various intangible and non-contributory costs are often incorrectly captured in the assessment of complex properties. This happens when cumulative historical costs reflected in the accounting records are relied upon to estimate fair market value.

Problems arise when accounting records reflect changes in carrying basis, adjustments for impairments, step-up or fresh-start accounting, allocations and purchase prices that may not be communicated accurately on property tax returns. The changes in basis may have a negative impact on the assessor’s trended costs.

Another concept that comes into play is “original cost,” which may represent an alternative carrying basis or the purchase price of used assets. There can also be issues in value outcome associated with “in service” dates that are different from the true vintage of the equipment.

An additional problem area is the impact of cumulative investment over time. Such investment may include rebuilds, capitalized maintenance, and other non-value added costs (e.g., relocation, demolition) that wind up in the accounting records. Many projects are capitalized in bulk or summary fashion, which makes it difficult to effectively track retirements or partial replacements.

Negotiating a Reduction

There are countless variables involved with valuing complex properties. Therefore, it’s often necessary to consider the input of experienced consultants and industry experts to determine the accuracy of a property tax assessment.

The assessor’s cost approach may adequately measure the property’s replacement cost new. However, if the proper adjustments for depreciation and obsolescence are not made, the assessment will be excessive and not reflect fair market value.

Thorough research can provide the proof to convince assessors and appraisal review boards of the true fair market value. In this way, industrial taxpayers can receive significant reductions in their property assessment and the resulting tax bill.