FEATURE ARTICLE, AUGUST/SEPTEMBER 2012

RULING CREATES PROPERTY TAX APPEAL OPPORTUNITIES
Pennsylvania court ruling requires tax assessors to value both the landlord’s position and the tenant’s position to determine the market value for tax purposes.
By Sharon DiPaolo, Esq.

DiPaolo

The Pennsylvania Supreme Court recently up-ended 20 years of law and practice regarding how leased real property is valued for taxation. In its long-awaited April 25 decision on Tech One Associates vs. Board of Property Assessment Review and Appeals of Allegheny County, the Court moved Pennsylvania closer to most other states that practice fee-simple valuation for property tax assessments.

Value All Real Estate Interests

The Court ruled that when real property is leased, an assessor must value both the landlord’s position (leased fee) and the tenant’s position (leasehold) and add them together to determine the market value on which the property should be taxed. Leasehold refers to a tenant’s rights in real property, the value of which can vary widely based on the lease terms.

To illustrate, consider an area with $12 per square foot market rent. A tenant paying below-market rent, say $3 per square foot, has a superior position compared to other tenants in the market, meaning their leasehold value is a positive number. Conversely, a tenant paying above-market rent of $25 per square foot has an inferior position compared to other tenants in the market, thus, their leasehold value is a negative number. Adding the leased fee and leasehold interests together will tend to bring the value of the property in line with the market rent, and thus, all properties in the same market will be valued similarly. By valuing the entirety of the rights in a piece of property, the Tech One decision represents a sea change from how leased properties were valued throughout the state since the Court’s 1992 decision in Marple Springfield Center.

For 20 years, Pennsylvania’s lower courts and practitioners interpreted Marple Springfield to mean that, for leased real property, only the leased-fee interest should be valued. In practice, this meant that properties across one class — for example, department stores — could be taxed unevenly depending on their lease structures. If the tenant built its building on leased land, the building was essentially untaxed because only the landlord’s position — the rent it received for the land — was valued. But if the landlord built the same building and leased it, both the land and building were taxed because the landlord received rent for both.

In Tech One, the landowner had granted a land lease to a developer at a flat $660,000 per year for 50 years. The developer then constructed a large shopping center on the site.

At trial, the landowner argued that only its interest should be valued and introduced evidence of a $9 million leased fee value. The landowner argued that it did not receive income from the buildings, and under the Marple Springfield decision, it should only be taxed on income received under the ground lease.

The taxing districts retorted that both land and buildings are subject to taxation, and that divided ownership interests are an insufficient basis to tax them differently from non-leased properties. Accordingly, the taxing districts entered evidence of both the $9 million leased fee and a leasehold interest, arguing that the aggregate of those interests — approximately $25 million — was the property’s correct assessment. The Court agreed that assessments of leased real property must reflect the market value of both the leased fee and leasehold interests to achieve uniformity of taxation. To rule otherwise, the Court held, would be to allow a situation where a tenant under a long-term lease “could build a Taj Mahal and the structure would be wholly exempt from taxation merely because it was owned as a leasehold.”

Implications For Taxpayers

Properties that have been overvalued in Pennsylvania due to above-market leases should see their property assessments adjusted downward when the tenant’s position is accounted for. Specifically, owners of buildings built under turn-key leases and build-to-suit properties, such as drugstores, which have been historically overvalued in Pennsylvania, should pursue tax appeals to achieve the benefit of the Tech One decision.

Properties that have enjoyed the benefits of lower taxation (such as below-market, ground-leased properties) will likely see aggressive tax appeals by taxing districts looking for new revenue streams. When entering into leases in Pennsylvania, both landlords and tenants will need to be mindful of the allocation of real estate tax responsibility, and in particular, should address who will be responsible for escalation in taxes under the new law.

On a practical level, Tech One will result in taxing of leased real property on a uniform basis, meeting Pennsylvania’s constitutional requirement of uniformity in taxation. It will also meet property owners’ sense of fundamental fairness.

Sharon DiPaolo is a partner in the law firm of Siegel Siegel Johnson & Jennings, the Ohio and Western Pennsylvania member of American Property Tax Counsel, the national affiliation of property tax attorneys.

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