Winter 2022 Insights

Taxpayers, tax counsel, tax assessment authorities, and valuation analysts (“analysts”) sometimes use market-derived pricing data from publicly traded stocks and bonds (“capital market data”) when developing unit principle valuations for property tax purposes. Sometimes analysts directly use these capital market data in the application of the income approach, market approach, and cost approach in unit principle property appraisals. Analysts may use these securities data to develop yield capitalization rates, direct capitalization rates, pricing multiples, and required rates of return (to measure either entrepreneurial incentive or economic obsolescence). However, securities often have risk and expected return investment characteristics different than the taxpayer’s property that is the subject of the unit principle appraisal. In particular, securities are different than taxpayer property with regard to the investment attributes of (1) operational control and (2) marketability. Therefore, analysts often consider control price premium data and discount for lack of marketability studies to estimate a valuation adjustment to apply in a unit principle property appraisal that relies on capital market data. This valuation adjustment may be applied to account for differences in the risk and expected return investment attributes of publicly traded securities compared to taxpayer industrial and commercial property. Like all valuation adjustments, such an adjustment is intended to make the “comparables” (i.e., the publicly traded securities) more like (i.e., have the same investment characteristics as) the “subject” (i.e., the taxpayer’s taxable property). This discussion summarizes the development of such a valuation adjustment when capital market data are directly used to develop a unit principle appraisal of taxpayer property for property tax purposes.

Many industrial and commercial taxpayers are subject to the unit principle (sometimes called the utility principle) of appraisal for property tax purposes. In addition to centrally assessed utility-type taxpayers (e.g., electric companies, telephone companies, railroads, airlines, pipelines), locally assessed taxpayers in many industries are often subject to the unit valuation principle. Unit principle appraisals typically encompass the value of all of the taxpayer operating property, including working capital assets, real estate, tangible personal property, and intangible personal property. However, many taxing jurisdictions only tax real estate and/or tangible personal property for property tax purposes. Therefore, taxpayers operating in taxing jurisdictions that do not tax intangible property have to value such property—and exclude that value from the taxable bundle of taxpayer property. Many unit principle appraisal methods capture the value of the taxpayer’s intellectual property, including patents and technology, copyrights, trademarks and trade names, and trade secrets and know-how. This discussion summarizes the application of the market approach—and particularly the relief from royalty method—to value a taxpayer’s intellectual property. In particular, this discussion focuses on the valuation analyst’s use of license royalty rate databases in the valuation of taxpayer intellectual property for ad valorem property tax purposes.

Analysts are often asked to appraise a taxpayer’s industrial or commercial property for property tax compliance, appeal, or litigation purposes. Often, analysts apply the summation valuation principle to appraise such industrial and commercial property. For complex properties that are physically, functionally, or economically integrated, analysts sometimes apply the unit valuation principle to appraise the industrial or commercial property. These analysts apply generally accepted unit principle property appraisal approaches and methods. Most of property appraisals involve the analyst’s measurement of cost of capital. This cost of capital becomes the basis for the analyst’s development of the applicable yield capitalization rate or direct capitalization rate. For most unit principle appraisals, the yield capitalization rate and direct capitalization rate include the analyst’s estimate of a property-specific risk premium (“PSRP”). This discussion explains the reasons why the PSRP should be included in the various cost of capital measurement models. This discussion describes the qualitative factors that the analyst considers in the judgment-based PSRP estimate. This PSRP estimate is one component of what is often called “alpha” in the measurement of a property-specific cost of capital. This discussion also summarizes the market-derived, empirical data sources that the analyst may consider as a proxy—or benchmark—in the quantitative estimate of the PSRP. These empirical data sources do not directly measure the PSRP. That is because the PSRP is unique to the subject property. However, these empirical data sources provide general guidance to support the PSRP estimate. Finally, this discussion summarizes one procedure that impacts both the qualitative and quantitative assessment of the PSRP: the functional analysis of the taxpayer property.

The industrial and commercial property (e.g., special purpose property) of some corporate taxpayers is assessed for ad valorem property tax purposes based on the unit principle of property appraisal. That is, these taxpayer’s industrial or commercial property is valued as one operationally, functionally, and economically integrated “unit.” Valuation analysts (“analysts”) working for either taxing authorities or taxpayers may apply cost approach methods to value the taxpayer’s special purpose property. As part of the application of the cost approach appraisal methods, analysts should consider all components of depreciation—including functional and external obsolescence. The measurement of obsolescence is sometimes a topic of disagreement between analysts in property tax assessment appeals. This discussion focuses on several common misconceptions related to the measurement of obsolescence in the appraisal of special purpose industrial or commercial property. And, this discussion recommends several best practices responses to these common misconceptions.

Many private companies are structured as S corporations for federal income tax purposes. And, many private companies may be attractive acquisition targets—particularly to private equity firms and to leveraged management or employee buyers. This statement may be particularly true for private companies owned by baby-boomer-generation owners. Private equity firms—and management/employee buyers—often want the selling shareholders to retain a small amount of the S corporation equity. That is, the buyers want the selling shareholders to have some “skin in the game” during the ownership transition period. If this is a transaction consideration, both the corporate acquirer and the selling shareholders should consider an “F reorganization” as one component of the overall transaction structure. This discussion summarizes the income tax benefits (and the income tax costs) of an F reorganization structure as part of the sale and purchase of an S corporation.