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Friday, June 3, 2011

Economic Obsolescence Could Be a Winning Argument for Reductions in Local Property Tax


In the midst of a severe economic downturn, it is no surprise that many manufacturing businesses have reduced production or shut down plants. But many industrial operators may not be focused on an opportunity that the downturn presents to argue for a break in property taxes. Recently, BNA talked with Bob Henderson, national director of property tax with Ernst & Young LLP, about the impact of economic obsolescence on the assessed value of property. The full interview appears in the Feb. 5, 2010, State Tax Weekly. What follows is an excerpt from that discussion:

BNA: You suggest that taxpayers ought to consider economic obsolescence in valuing their property. What do you mean by that exactly?

HENDERSON: There are three kinds of obsolescence or depreciation. There's ordinary, physical wear and tear—what we call standard depreciation, which is factored into virtually every property tax assessment. Then there's functional depreciation, which measures circumstances unique to the assets—such as unusually high repair costs or failing to do the job for which it was selected. The third kind is economic obsolescence, which is external to the organization, to the asset. It takes place due to business conditions or changes in regulation

BNA: And yet economic obsolescence is rarely used?

HENDERSON: Most jurisdictions recognize it; it's a standard appraisal doctrine.  Still, economic obsolescence is the least understood form of depreciation and the least utilized, particularly on the manufacturing side.

BNA: So where do you start?

HENDERSON: There are certain questions that should be asked. First, has employment declined? If you were running six lines and now you're running two, clearly those machines are not being used the way they were. So, the first thing is to identify it and put numbers around it. And the way to do that is to start with normal capacity.

We recommend for the purpose of analysis to go back and look at three years of production to get a feel of where production was and how it changed. Then show what happened to production, on a monthly basis. If I made 100 widgets a month in 2007, and 80 in 2008, and 60 in 2009, I know I've got an issue.

BNA: We're in an economy in which many states and localities are looking everywhere they can for revenue. Do you expect taxpayers who make an argument for economic obsolescence will meet with a lot of resistance from local assessors?

HENDERSON: In today's environment, all jurisdictions are hurting, whether it's the school board, the city or the county. And there is pressure on the assessor community. However, fundamentally, they are a group of professionals whose job it is to get it right.

If I am the only employer of 600 people in the county, and I've got an economic obsolescence issue, there has to be some consideration given. It is in the interest of the community because the business is providing jobs. If your property tax burden is inequitable or inaccurate, then that may be the difference between the plant operating here or operating in a lower tax environment.

BNA: Or not operating at all.

HENDERSON: The goal is accuracy, and most jurisdictions want accuracy, too. So first you come up with a number, then you document it, and if necessary you invite the assessor in to see the facility. They can see that two lines are sitting vacant. Call it show and tell. Show where your information comes from.

And don't wait to just file an appeal. Call the assessor, reach out to him before you get into that cycle. Say "I've got an issue, I've got this documentation." Budgets don't get set at the beginning of the year, so the earlier you can act with the assessor, the more likely you'll be successful, and the less likely you'll put them in the position where they are simply playing defense.

BNA: Just given how bad things have been, do you expect to see more companies use this form of depreciation in 2010?

HENDERSON: Yes. Things did not really fall off the table until September 2008.

BNA: Which suggests that there could be a lot of downward pressure on property tax collections this year.

HENDERSON: Property tax is fundamentally a lagging indicator. It's an imperfect way of doing it, but what the property tax does is look at the past and attempt to make an assumption about the future.

Another factor is that, historically, when we had declines in industrial demand, if a facility was being shut down, even if there was not a U.S. market, you could ship used equipment or machinery to the developing world. That's not going to happen any more. Russia, China, India are all making new equipment in their own localities. The overseas market that used to prop up personal property values doesn't exist any more.

Look at what happened in the south when the textile industry substantially disappeared—and it did just that, the domestic manufacturing base of the U.S. textile industry virtually disappeared.

The key lesson for both industry and government is that change is inevitable, whether driven by the business cycle or larger, global economic forces, and both parties have to use all of the tools and flexibility afforded by statute to insure that the local business tax climate accurately and equitably reflects current market conditions to allow both the firm, and the community it is a part of, to adapt and thrive.

By Dolores W. Gregory

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