Summer 2020 Insights

Many taxing jurisdictions do not tax intangible property for property tax purposes. However, many taxing jurisdictions assess certain industrial or commercial property based on the unit principle of property valuation. The application of the unit valuation principle typically includes the value of all of a taxpayer’s operating property, including intangible property. The inclusion of intangible property in such a tax assessment can, in some cases, substantially affect the amount of the assessment. For this reason, property owners may retain a valuation analyst to value and subtract any intangible property from the unit principle valuation. First, this discussion summarizes the unit principle valuation of industrial and commercial property. Second, this discussion describes the identification of intangible property and the generally accepted intangible property valuation approaches and methods applicable for property tax purposes. Finally, this discussion presents two methods that are frequently applied to remove the value of intangible property from a unit principle valuation prepared for property tax purposes.

Valuation analysts (“analysts”) are often called on to value an industrial or commercial taxpayer’s intangible property for property tax purposes. The first procedure in any intangible property valuation is the selection of the appropriate valuation approach (or approaches) to apply to the intangible property. The generally accepted intangible property valuation approaches are the cost approach, the market approach, and the income approach. The analyst then selects one or more of the generally accepted valuation methods within each selected approach. The selection of valuation approaches and methods is based on various criteria, such as the quality and quantity of available data and the analyst’s professional judgment. This discussion describes the generally accepted intangible property valuation approaches, methods, and procedures that may be applicable for property tax compliance, appeal, or litigation purposes.

The consideration of both functional and external obsolescence is an important procedure in the application of the cost approach to value industrial or commercial property. Technological changes may cause industrial or commercial property in many industries to experience functional obsolescence. Changes in the subject industry economics may cause industrial or commercial property in many industries to experience the economic obsolescence component of external obsolescence. Taxpayer property owners should recognize the effect that such obsolescence may have on the value of their industrial or commercial property for property taxation purposes. This discussion summarizes best practices considerations for both the identification and the measurement of obsolescence in the cost approach valuation of industrial or commercial property.

Appraisals of industrial or commercial tangible personal property (“TPP”) prepared for property tax purposes are often subject to contrarian review. In order to withstand such a contrarian review, the TPP appraisal should rely on generally accepted property appraisal approaches, methods, and procedures. This discussion summarizes the generally accepted property appraisal approaches, the generally accepted property appraisal methods applied within each approach, and the individual procedures that would be applicable to the appraisal of special purpose industrial or commercial TPP for property tax purposes.

The consideration of both functional and external obsolescence is an important procedure in the application of the cost approach to value industrial or commercial property. Technological changes may cause industrial or commercial property in many industries to experience functional obsolescence. Changes in the subject industry economics may cause industrial or commercial property in many industries to experience the economic obsolescence component of external obsolescence. Taxpayer property owners should recognize the effect that such obsolescence may have on the value of their industrial or commercial property for property taxation purposes. This discussion summarizes best practices considerations for both the identification and the measurement of obsolescence in the cost approach valuation of industrial or commercial property.

The capital asset pricing model (“CAPM”) is a generally accepted cost of equity capital measurement model. The CAPM is often applied to estimate the present value discount rate (or yield capitalization rate) in an income approach valuation of industrial or commercial property. The CAPM was developed to estimate the required rate of return on an investment in perfectly liquid equity securities. Therefore, it may not be appropriate to rely on the CAPM, without modification, to estimate the discount rate applicable to the appraisal of industrial or commercial property. This discussion focuses on certain conceptual limitations and application considerations in using the CAPM to value property for property tax purposes. This discussion also presents several alternative cost of equity capital measurement models.

The property-specific risk premium is an important consideration in unit principle valuations of industrial or commercial property performed for property tax purposes. This risk premium is a component in the estimation of the cost of equity capital used to develop the unit principle valuation discount rate or direct capitalization rate. An investment in industrial or commercial property has different risk and return characteristics (and is generally more risky) than an investment in a diversified portfolio of marketable securities—the benchmark that is often used to estimate the taxpayer’s cost of equity capital. This discussion presents (1) various factors that may be considered and (2) several procedures that may be applied to estimate the property-specific risk premium in the unit principle valuation.

Valuation analysts (“analysts”) often work with legal counsel and tax advisers to design and implement buy/sell agreements for closely held companies. These buy/sell agreements are intended to achieve several operational and taxation objectives—both for the company owners and for the private company itself. This discussion summarizes typical buy/sell agreement structures, ownership transfer funding mechanisms, ownership transferability restrictions, valuation and pricing provisions, and transfer tax planning and compliance considerations.

Valuation analysts (“analysts”) are often asked to assist with the pricing and structuring of private company sale transactions. Analysts will often perform particular due diligence procedures with regard to the sale of the S corporation private company. These due diligence procedures often include the analyst’s review of the private company buy/sell agreements, stock redemption agreements, and other shareholder agreements. This due diligence may relate to the concern that the shareholder agreement (particularly the shareholder agreement share pricing provisions) may have created a second class of company stock. Such a second class of company stock could possibly invalidate the private company’s S election. Such a concern would affect both the corporate acquired and the individual sellers of the S corporation private company. This discussion focuses on the analyst’s review of such shareholder agreements, particularly during the structuring of the S corporation/private company sale transaction.