POSSESSORY INTEREST THE WHAT, WHEN, HOW AND WHERE

POSSESSORY INTEREST THE WHAT, WHEN, HOW AND WHERE Matthew Burke, Esq. Counsel Pillsbury Winthrop Shaw Pittman LLP Los Angeles, California (213) 488-7355 Matthew.Burke@ pillsburylaw.com Mindy McLees, CMI Director Property Tax Group Leader Moss Adams LLP Los Angeles, California (310) 295-3717 Mindy.McLees@ mossadams.com

INTRODUCTION Why? Government entities largest property owners and largely exempt. Taxing PIs: 1850s in California vs. recent history other states We ll cover: Basic Concepts and Examples Valuation Principles Multi-State Specifics 2

BASIC CONCEPTS PI = possession/right to possession of real property independent of the fee simple ownership (possess property owned by another). Taxable PI = PI held by a private party in exempt government owned property. Real property bundle of rights split in a leasehold, license, easement and concession. Elements: Durable Exclusive Private Benefit 3

EXAMPLES Cattle grazing permit & agricultural leases Port/harbor berthing area leases Employee & faculty housing Car rental counter Airport parking lots Airport terminal areas Airport garage Timber contracts Air landing rights Oil and gas leases Indian land leases Cable TV franchise River rafter permits Snack concessions Ski resort permit Convention center Boat slip 4

EARLY LAW Started in California with private mining claim on federal land, in State v. Moore (1859) 2 Cal. 56. Then with adverse possession of federal land for agricultural purposes, in People v. Shearer (1866) 30 Cal. 645. California Supreme Court established three required elements durability, exclusivity, private benefit - in Kaiser Co. v. Reid (1947) 30 Cal.2d 610. Later, independence was added. 5

DURABILITY Means the possessor s use has to be for an ascertainable period of time. Can be short example: permit holder renting space at convention center for a few days per year (though must be continuous or recurring). Month-to-month is durable. Durable even if government can terminate. Duration goes to valuation. 6

INDEPENDENCE Possessor is not an agent of the government. Possessor exercises significant authority and control over management and operation separate from the government rules and regulations. Pacific Grove-Asilomar Operating Corp. v. Monterey County (1974) 43 Cal.App.3d 675. 7

EXCLUSIVITY Does not mean exclusive against everyone else. Use is not shared by the general public. Allows for co-uses and concurrent uses. Korean Air Lines v. County of Los Angeles (2008) 162 Cal.App.4th 552: Exclusive even though airline shared possession of airport terminal with federal government. Vanguard Car Rental USA, Inc. v. County of San Mateo (2010) 181 Cal.App.4th 1316: Exclusive even though company shared garage with 6 others. 8

PRIVATE BENEFIT Private benefit means that the possessor has the opportunity to make a profit. Does not actually have to make a profit. In California, does not require a business or commercial purpose, but in some other states a commercial use for profit is required. 9

VALUATION QUESTION What is the appraisal problem? Entire value not taxable: Remove rights not granted to the possessor. Remove the government owner s reversionary rights. Basically two methods: Value present interest of rights held by possessor (would necessarily exclude reversionary rights). Value full fee interest and remove appraised present value of government owner s reversion and retained rights. 10

COST APPROACH Step 1: Determine reproduction cost new of the building or improvements (or actual cost, if new). Step 2: Reduce the cost by depreciation. Step 3: Add land value to the improvement value. Step 4: Reduce total of land and improvements to present value today of the government s reversion. Step 5: Remove government s reversion. Important: Consider costs that do not add value, consider changes in real estate market. 11

COST APPROACH Difficulties in appraising and reducing to present value the government s reversion. Requires agreement on discount rate. Requires agreement on appreciation factor. Requires agreement on depreciation. What if must remove improvements at lease termination? 12

SALES COMPARISON APPROACH PIs usually are complex properties with complex leases. Sales comparison approach is limited: Lack of comparable sales of the leasehold interests. Lack of sales of comparable fee simple properties that could be adjusted. 13

Best indicator. Consider: INCOME APPROACH Expenses of governmental owner related to income stream. Duration of lease, or anticipated term of possession. Anticipated future income & factors that could affect that. Risks inherent in maintaining income stream (affect cap rate). Proper discount rate? 14

INCOME APPROACH Expense ratio is the big issue. Income approach is based on gross return less gross outgo. Issue what is included in gross outgo? Issues in California with ports. 15

INCOME APPROACH California, Assessors Handbook Section 510, Assessment of Taxable Possessory Interests: When estimating the income to be capitalized, or net return, from operating income, all elements of gross outgo, or allowed expenses, whether paid by the landlord/public owner or by the tenant/possessor, must be subtracted from the gross return. Elements of gross outgo, or allowed expenses, include the following, as applicable: cost of goods sold, typical operating expenses, typical management expense, an allowance for a return on working capital, and an allowance for a return on and a return of the value of any nontaxable property that contributes to the gross operating income. (Pages 31-32, emphasis added.) 16

INCOME APPROACH California BOE AH 510 definition of typical operating expenses : Typical operating expenses may include expenses for the rental of personal property, for the provision of security services, and for advertising and promotional services, provided such expenses are necessary for the production of the gross income from the subject taxable possessory interest. Typical operating and management expenses include expenses that an owner/operator typically would bear to maintain the property and to continue the production of income from the property but which, in the case of the subject taxable possessory interest, are borne by the public owner. (Page 32.) 17

INCOME APPROACH Term of possession to be used in estimating the income stream. Not necessarily lease term. California rule is stated term unless clear and convincing evidence that reasonably anticipated term is shorter or longer. Causes large swings in value. Longer = reversion worth less, increases value of PI. Shorter = reversion worth more, reduces value of PI. 18

MULTI-STATE ISSUE Do some states illegally value the reversion? State property vs. federal property. Hawaii: [S]hall be assessed and taxed in the same amount and to the same extent as though the lessee were the owner of the property. Maryland: [A]s though the lessee or the user of the property were the owner of the property. Minnesota: [I]n the same amount and to the same extent as though the lessee or user was the owner of such property. 19

(Continued) MULTI-STATE ISSUE Nevada: Value of PI determined in same manner as it would be if the lessee was the owner of the property and it was not exempt from taxation. New Jersey: The private party is subject to liability for taxation to the same extent as though he owned the property. Oregon: Property of the federal government leased shall be valued at 100 percent real market value subject only to deduction for restricted use. Rhode Island: Taxed to the lessee who for purposes of taxation is deemed the owner of the property. 20

ALASKA PIs taxable under Alaska Const. Art. 9, 5. Alaska Supreme Court approved use of reversionary method estimates value of leasehold interest by taking value of fee interest and deducting both value of burden of use restrictions and value of reversionary interest. Method is recognized and appropriate to value PI. - Fairbanks North Star Borough Assessor s Office v. Golden Heart Utilities, 13 P.3d 263 (2000). 21

COLORADO 2001: Supreme Court case Board of County Commissioners v. Vail Associates, 19 P.3d 1263 (Colo.2001) Vail Associates test: Lease provides revenuegenerating capability to the lessee independent of the government owner; lessee can exclude others; and lease is of sufficient duration to realize private benefit. Colo. Rev. Stat. 39-1-103(17): Provides that value of ski area must be calculated by capitalizing annual fees paid to U.S. government in prior year. 22

CONNECTICUT Conn. Gen. Stat. 12-64. Broad exemption for leases at Bradley International Airport or any other state-owned airport. Exemption for any restaurant, gas station or convenience stores deemed appropriate for state highway, mass transit, marine or aviation purposes. 23

DISTRICT OF COLUMBIA D.C. Off. Code 47-1005.01 (enacted 2000): The Mayor shall determine the assessed value of the interest or use in accordance with 47-820(a)(3) as if the lessee or user of the real property were the owner of the real property and the real property were not exempt or immune from taxation; provided, that the taxable value may be adjusted by the Mayor to reflect the duration of the interest or use remaining; provided further, that the Mayor may impute a duration of the interest or use based upon the intent, actions, and policies of the parties to the conveyance, the history of the real property, the perception of third parties, and written documents. 24

Fla. Stats. 196.001. FLORIDA Basic rule is to tax leasehold interests in government property. Exemptions in Fla. Stats 196.199: Exempts private uses that serve or perform governmental purposes. Exempts exclusive uses for literary, scientific, religious or charitable purposes. Exempts some leaseholds in port property. 25

HAWAII Haw. Rev. Stat. 246-37: Taxes use or occupation by private party but only in connection with a business conducted for profit. [S]hall be assessed and taxed in the same amount and to the same extent as though the lessee were the owner of the property Lease = one year or more or renewable to constitute total term of one year or more. 26

IDAHO Idaho Code Ann. 63-309. Applies to property of state or any subdivision when the possessor has a contract of sale or lease with purchase option, with the lease money applicable to the purchase price. 27

Iowa Code 427.15. IOWA Applies when the lease contains an option of purchase, valued by deducting from the value of the land and improvements the amount of payments required by the lease to acquire title. 28

KENTUCKY Ky. Rev. Stat. Ann. 132.195. Applies when property is leased in connection with business conducted for profit. Exempts: Certain industrial buildings; federal property for which payments are made in lieu of property taxes; property of any state educational institution; vending stands operated by blind persons; property of any free public library; and certain property in operated by the Department of Military Affairs. 29

MARYLAND Md. Code, Tax. Law 6-102, 7-211. Applies to lessee of federal government, the state, county or any other municipality or agency, as if lessee were the owner of the property and the use is for a business conducted for profit. Exempts federal defense contractors; concessions at airport, parks, markets or fairgrounds; certain interests in port facilities; certain interests in an international trade center; vending facilities of blind; state university student housing. 30

MASSACHUSETTS Mass. Gen. Law. Ch. 59, 5, para. 2. Specifically applies the tax to commonwealth lands in Boston known as the commonwealth flats, if leased for business purposes and lands and flats lying below high water mark in Provincetown harbor, belonging to the commonwealth and occupied by private persons by license of the department of environmental protection together with all wharves, piers and other structures which have been built thereon after Mary 22, 1920. 31

MICHIGAN Mich. Comp. Laws 211.181. Applies if property leased or used in connection with a business conducted for profit. Taxed in same amount and to the same extent as if the lessee owned the property. Exempts federal property for which payments in lieu of taxes are paid; property of state university system; concessions at public airport, park, market, or similar property; property used in conjunction with a certain county and state fairs. 32

Minn. Stat. 272.01. MINNESOTA Applies if leased or used in connection with business conducted for profit. [I]n the same amount and to the same extent as though the lessee or user was the owner of such property. Many exemptions including for certain concessions and certain government airport property. 33

MONTANA Mont. Code. Ann. 15-24-1201: Applies the tax when property is leased with option to purchase with lease money applicable to the purchase price. Mont. Code. Ann. 15-24-1202: Applies the tax when property is held under contract of sale where title is to transfer after certain payments are made, without deduction for purchase price remaining unpaid. 34

NEVADA Nev. Rev. Stat. 361.157. Applies when leased or used in connection with a business conducted for profit or residence. Value of PI determined in same manner as if the lessee was the owner of the property and it was not exempt from taxation. 35

NEW JERSEY N.J. Rev. Stat. 54:4-1.10. When used in connection with an activity conducted for profit. Assessed and taxed as real property of the private party. The private party is subject to liability for taxation to the same extent as though he owned the property or any portion thereof, unless the owner consents to the taxation thereof. 36

N.Y. Tax Law 402. NEW YORK Applies when the possessor has a contract to buy the property or has an agreement where they could acquire the property through an option or right of first refusal. Calls this on the roll interest under contract or interest under option. 37

NORTH CAROLINA N.C. Gen. Stat. 105-282.7. Applies to cropland or forestland owned by federal government, state, county or any local municipality, leased or used in connection with business conducted for profit. 38

TENNESSEE Tenn. Code Ann. 67-5-203(c)(1). Applies the tax when the property is leased for the purpose of operating, or developing and operating, a golf course. Payments in lieu of ad valorem taxes are due in amount equal to the ad valorem taxes that would be payable on the current fair market value of the leased property. 39

OREGON Or. Rev. Stat. 307.060: Values the property leased from the U.S. government at 100 percent of real market value and assessed at assessed value, subject only to deduction for restricted use. Or. Rev. Stat. 307.050: Values and taxes U.S. government property under contract of sale the same way. 40

RHODE ISLAND R.I. Gen. Laws 44-4-4.1. Applied to state property except land and piers leased for 10 or more years including options. Taxed to the lessee who for purposes of taxation is deemed the owner of the property. Certain exclusions for nonprofit public uses, state property leased for airport, and state property leased to exempt taxpayers. 41

WASHINGTON Wash. Rev. Code 458-12-155, 458-12-170, 458-12-175. Applies to PIs on federal land if federal government holds land concurrently with the state. Exemption if the private PI holder is exempt from taxation elsewhere or the PI rights are held by public body. 42