Property Tax: It’s Based on Value-in-Exchange, not Value-in-Use

by DMA Staff | Oct 02, 2015

By: Patrick Price, CCIM | Director, Property Tax at DMA

A very protracted property tax case finally came to an end last month, when the North Carolina Supreme Court denied a county’s request for review. Many who track such litigation will be familiar with the “Parkdale Mills” cases…for those who aren’t aware, I’ll offer what I think is the most important observation.

First, we understand that the ad valorem tax system is based on the concept of everyone paying their “fair share” of the tax burden. As opposed to an income-tax or consumption-tax, this is based upon the value of owned-property (property wealth). It is not related to original cost or expense, but is in direct proportion to the property’s current fair market value – what would the property sell for if exposed to the market, without duress or atypical influences? Most laws and statutes governing the property tax system and methods of assessment clearly dictate this fair-market-value standard. And it is indeed the primary method used by most tax assessors throughout the country (with some jurisdictional nuances from state-to-state that are unnecessary for the present summary).

However, where many disputes arise is in the valuation of depressed industries or properties that have depreciated due to various conditions. This can be a function of economic changes, global competition, or simply market declines. And it is often little more than a reflection of the imbalance in demand versus supply – there is an abundance of such property or space, and fewer buyers - creating negative pressure on sale prices (as with any other product).

In such situations, we sometimes find assessors or other parties attempt to employ a “different kind of value” methodology or premise…one that can be referred to as “Value-in-Use” rather than Market Value. The idea is that the property may have more intrinsic value to the current user, than it does to the market if they attempted to sell it. In such situations, arguments will be made that “as part of the ongoing business enterprise – the collection of assets in service – or as part of the going-concern”, the property is being utilized for economic profit by the current user. Thus, they posit that this type of value to the current owner should be the basis of its assessment, rather than the price at which the property would sell if exposed to the market in a hypothetical transaction.

One of the first problems that arises in this concept is the proper allocation of the value that is really attributable to the real estate – it is most often overstated, as the intangible components creating value are very difficult to ascertain and quantify (management, contracts, vendor relationships, brand value, the in-place and trained workforce, etc). The second problem that arises when employing this standard is that you have now discriminated against an individual property or asset-class, using a different valuation premise or measurement than is used for all others.

In its simplest form, this can be explained by observing that we do not estimate the value of office buildings based on the businesses operating therein – i.e. the assessments of doctor’s office, or insurance offices, or other professional offices aren’t appraised based on the value of the “practices” operating therein. Neither are assessments of retail stores based on the value of the businesses’ sales or brand.  Otherwise, you could have identical buildings sitting right next to each other, but taxed at extraordinarily different values based on the success of the enterprise operating inside. Rather, what is being appraised is the “dirt, sticks and bricks”…the real estate. Now back to the original substance of this article, the “Parkdale Mills” cases in North Carolina…

There are many facets of this case that will draw the interest of legal experts, related to process or burden-of-proof, as well as other legal maneuverings. But what I think is of most substance to taxpayers is that the “Value-in-Exchange” or Fair Market Value premise was emphasized as the appropriate standard for property taxation in NC. In summary, this case was a dispute over the assessor’s valuation of real property and was appealed to the state-level Property Tax Commission.   The taxpayer subsequently appealed the matter to the Court of Appeals, which remanded the case back to the Commission three times, with greater emphasis on the important factors each time. Most notable to me was the clarity around Market Value, which the Court addressed directly, in one such instance as follows:

"The dictate of ad valorem taxes is that the value of the property is the price at which the property would likely change hands between a willing buyer and equally willing seller.  See N.C. Gen. Stat.  §105-283 (2011). By emphasizing the fact that Parkdale uses these facilities industrially to produce yarn 24-hours a day, the Commission’s findings implicitly allow the County to measure the value of the properties as their subjective worth to Parkdale.  Such a valuation is obviously not the same as adequately determining the objective value of these properties to another willing buyer." 

Again, this is not new…Market Value has been the standard in North Carolina all along. But the issue had been clouded or confused by some practitioners who attempted to assign this “alternate value” to a single user, ignoring the market altogether and focusing on an approach that resulted in higher assessments (and prices that could not be realized or obtained if one tried to sell the real property under normal conditions). It was improper, but absent the challenge and clarity needed from higher authorities, was becoming more pervasive.

Personally, I’m very pleased to see the clarification and direction so explicitly stated by the Courts. While there will likely always be differences of opinion regarding valuation, such disputes can be more easily resolved if all parties are starting with the same definitions and directions. The Parkdale Mills case, and others, should help in that regard for NC taxpayers.

Please do not hesitate to contact your local DMA office should you have specific questions or requests.