Avoid the headaches of intangible asset disputes during the transaction process by appropriately using a property’s deed and transfer tax return.
While enthralled with the current presidential campaign process—sometimes in horror—I feel compelled to get on my stump and once again deliver my speech about how buyers have an invaluable one-time opportunity to help themselves when closing on a hotel.
For 30 years I’ve been making the arguments that operating hotels have significant “business value,” “intangible value,” “going concern value,” or “goodwill”—whatever you want to call it. Most, if not all, honest and informed people agree that an operating hotel is indeed much more than simply real estate. But when it comes to valuing an operating hotel for real estate taxation purposes, it is necessary to measure that non-real estate component and separate it from the going concern value in order to impose a tax on the value of the real estate only. This is where all the controversy comes in—not only how to separate the intangible value but how to support it with data from the marketplace.
To directly address this lack of information in the marketplace, I focused on owners’ ability to help themselves by including in the buying process a negotiation of the price allocation to more precisely paper their deal at closing and record deeds with a real estate-only value. That focus has more recently gained recognition in the deal-making process as more and more owners have elected to put that extra step in an otherwise enormously detailed pre-closing process.
So it was with great despair that I learned of a transaction that allocated the purchase price among the asset classes—real estate, tangible personal property and intangible property—only to find out a year and half later that that allocation was ignored on closing day and the entire purchase price placed on the deed when it was recorded. That fact was revealed in a real estate tax appeal hearing when the tax assessor used the amount recorded on the deed as evidence of the price paid for real estate only. Even when a representative of ownership attended the hearing and presented evidence that the allocation of the price was negotiated prior to closing. Even when the allocation to the real estate only was more than 80% of the entire price–not only a valid conclusion supported by independent evidence but a very reasonable position.
So here are the cold, hard facts. When you sign a real estate transfer tax return, you are signing, under oath, that the price you are disclosing is the price paid for real estate. When you record a deed that transfers the ownership of real estate with a price stamped on it reflecting how much transfer tax was paid and how much was paid in documentary stamp taxes, you are disclosing, under oath, a price paid for real estate.
It is very difficult, if not impossible, to try to argue after the fact that the price included intangible value. It is possible to “un-ring” the bell, so to speak, by filing for a transfer tax refund, usually available within a two-year statute of limitations—which varies by state and locality—and rerecording the deed. All of these require more time and expense, neither of which the dealmaker has once it has closed.
Assessors are looking for documentation that “proves” there is an intangible asset component for an operating hotel. For public companies, assessors peruse U.S. Security and Exchange Commission (SEC) filings, K-1s, etc., and they often ask for copies of federal income tax returns. Of course when they do not find any Generally Accepted Accounting Principles (GAAP) supporting the idea of intangible assets, they use that as evidence that they do not exist. When the Internal Revenue Code was amended in 1993 to include Section 197—which grants intangible assets, including goodwill and 15-year amortization status—hotel owners had reason to separate the intangible from the real estate for federal tax purposes. Federal tax returns of non-real estate investment trust ownership entities would support the fact that there are intangibles, but for various reasons owners rarely disclose federal tax returns to real estate tax assessors. Not the least of which is because nowhere in the appraisal process that determines fair market value of real estate do federal income taxes come into play. But the best evidence an owner can provide to support and provide evidence for the existence of an intangible asset in their purchase is the recorded deed and transfer tax return.
Buyers of operating hotels need to include in their closing process a step to allocate the price among real estate, tangible personal property and intangible property, and to negotiate that allocation with the seller such that both parties agree. Then close the deal consistent with that agreement and disclose on the realty transfer tax return (if applicable) the price for the real estate only and record the deed with the price for the real estate only—which is total consideration less value of tangible personal property and less value of intangible property. This will provide the proof assessors are looking for in the marketplace to support the existence of intangibles in hotel transactions.
Bernice T. Dowell is the President of Cynsur, LLC and a former Senior Manager of Paradigm Tax Group. 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 Masters of Science in Finance program and focused her senior thesis on the topic of hotel investment analysis and the contributory value of a tradename to a going concern.
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