Preparing for real estate tax due diligence
Preparing for real estate tax due diligence
18 SEPTEMBER 2013 6:25 AM

The cost of having a tax projection prepared for due diligence far outweighs the cost of making a bad deal.

When preparing a pro forma for a possible acquisition, do you simply look at historical taxes and bump them up at an arbitrary inflation rate? Have you considered that the property tax expense line item in a historical operating statement is an accrual of numbers?

How many deals are done this way? How many times have asset managers pulled their hair out because a newly acquired property is not making pro forma due to real estate taxes being more than twice what was expected?

Benjamin Franklin said, “An ounce of prevention is worth a pound of cure.” His wisdom is never more true when considering the property tax line item during due diligence.

Real estate tax due diligence needs to be a “ground up” analysis. Asset managers must consider the current assessment (value) of the property and the current tax rate and then consider what the future assessments and future tax rates will most likely be. And crucial to this analysis are the impact of the potential sale price and the timing of when that new information will be used by assessors.

The price is also important. How will that price affect future assessments? When only the price and the current tax rate are used for the pro forma, the deal is often unsuccessful. That is, dealmakers really do not want to know what the future taxes might look like because it kills the deal. This is when the property tax line item essentially gets fudged, and asset managers are left, post-acquisition, trying to manage an asset that is never going to make pro forma because of real estate taxes.

The price paid for a new acquisition is a price paid for an operating hotel. The assets that are purchased include real estate, tangible personal property and various types of intangible personal property. In the due diligence process, it pays to have an experienced hospitality real estate tax consultant prepare a tax projection that specifically considers the price paid for real estate and the timing of when that information will be used by the assessors going forward. The deal then has to be papered consistent with these assumptions.

An independent analysis pays dividends
It pays to have an independent price allocation analysis prepared as part of the deal-closing ritual and then close the deal accordingly. The key word is “independent.” The preparer of the pricing analysis should be separate and distinct from the property tax appeal service provider.

At closing, real property transfer taxes, if applicable, are calculated based on the price paid for the real estate only. The deed is recorded with the price that is paid for the real estate (not the entire price). Then the paperwork will support any post-acquisition tax appeal efforts should they be required, and your appeal service provider will have a report from an independent source supporting the pricing analysis.

If the deal is recorded this way, most likely the assessor will use the information as recorded to reassess the property. That ounce of prevention will go a long way in avoiding future over-assessments, however, in the case of over-zealous assessors. The paperwork filed at closing, signed under oath, will support the appeal efforts—not kill them. On average, the pricing analysis will reduce the prospective real estate taxes by 20% or more for each year of the holding period.

The preparer should explicitly show actual assessments (values) and actual tax rates as well as projected future assessments (values) and tax rates to arrive at real estate taxes. The preparer also should consider how and when the potential price will affect future assessments (values) using only the portion of the price attributable to real estate—not the entire price.

If you are lucky enough to go from signed letter of intent to signed purchase and sales agreement, use an independent expert who can prepare a pricing analysis to allocate the price among the asset types that are included in the deal, and use that information for the paperwork to close the deal. An independent expert means someone who is not necessarily affiliated with the property tax consultants who provide appeal work.

The cost of having a tax projection prepared for due diligence far outweighs the cost of making a bad deal. Once you have a deal, the cost of having a pricing analysis prepared to close the deal is recouped many times over in terms of transfer tax savings and reduced prospective real estate tax exposure. Both “ounces” of prevention are well worth the “pounds” of cure.

Bernice T. Dowell is a former senior manager of KPMG and president of Cynsur, LLC. She has focused her career in real estate transfer and property taxes on hospitality assets and the concept of removing the value of intangibles from a going concern. She began this endeavor as an employee in Marriott’s Tax Department in 1991. While at Marriott she was a member of the inaugural class at George Washington University for the Master of Science in finance program and focused her senior thesis on the topic of hotel investment analysis and the contributory value of a trade-name to a going concern.

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