Top tips for accounting firms on how to determine property value

Property tax is a high-cost expense for many businesses. It also involves navigating complex compliance requirements — sometimes multiple sets of requirements if a business owns more than one property. Many businesses pay more than they should in property taxes annually due to the heavy burdens of compliance along with a lack of knowledge around property valuation.

Adding services around this area gives you a tangible way to save clients money. Some organizations are overpaying by tens of thousands of dollars every year.

You can prevent that by making sure their assets are assigned a fair market value — and are therefore taxed correctly. Achieving this result requires asking the right questions, doing additional calculations, and calling out errors.

Diversifying your practice in this way can help you retain more clients, expand your client base, and drive revenue growth.

Tax assessors tend to go by the book. They have set ways of doing things and apply standard methodologies and data tables to determine values. As a result, sometimes they fail to take the nuances of a piece of property — real or personal — into consideration.

It’s invaluable for a company to have a knowledgeable party review an assessor’s work. That’s where you come in. If you’re considering expanding your offerings to include property valuation, the tips below can help you learn to uncover the true fair market value of company assets — which may or may not match the assessor’s calculation of value.

1. Market approach: What are other, similar properties selling for?
2. Income approach: What’s the profitability of the building and land?
3. Cost approach: What would it cost to replicate or replace the building, adjusting for all the differences between a new facility and the existing facility?

If good data is available, the market approach is most commonly used for real property. (For personal property, it’s the cost approach.) When you don’t have good comparison data, the next most common approach is the income approach, followed by the cost approach.

Note that appraisers are required to consider all three approaches for accreditation and ethical purposes. When valuing real property, you don’t always have to use all three approaches, but if you have good information for all three, do them all and correlate the results together to get a good indication as to value.

The income approach is applied to properties that generate income through lease payments. It determines value by asking what present value would reasonably support that future cash flow. This approach requires identifying the business owner’s profit on the property and converting that into value.

Assessors commonly use lease rates as the basis for the income approach. Current market lease rates reflect the value of the land and the buildings themselves (not the value of the business it houses). You can convert what a property leases for into value using a conversion factor called a capitalization, or “cap,” rate.

For example, if a building leases for $1,000 and the annual income that’s associated with the owner of that real property and the cap rate is 10%, you take $1,000 divided by 10%, and that equals $10,000 — this is the value of the property. (Note that you can make a value determination more quickly if a building owner has a triple net lease. With this type of lease, the tenant is responsible for all or some of the operating expenses, such as heating and cooling, maintenance activities, property tax, etc. In this case, very often the rental amount is nearly equal to the net profit, though you may need to consider other costs, such as insurance, that may not be part of the triple net lease.)

In doing these calculations, remember: All calculations need to be based on the property’s current value — what you could lease it for and profit from if you were to start all over again now.

That’s because most jurisdictions assess the tangible property values at the fair market value of the property as of their condition on January 1. A lease amount on an agreement signed 10 years ago may no longer reflect fair market value. Furthermore, if the lease is above market, then some of the value conclusions would equate to a beneficial contract value that is not a tangible asset.

A value derived from using current market rates is called a fee-simple lease as opposed to a leased fee. To determine the fair market value of the tangible assets — which is what’s taxable in most jurisdictions — use fee-simple profitability divided by the current prevailing market for cost to capital or that cap rate.

In addition, keep in mind that not only does the value of the asset itself change, but the cap rate may change every year as well. Interest rates have gone up in recent years, a scenario that translates into a higher cap rate and ultimately a higher property value.

Assessors use the cost approach in the absence of both similar transaction information and income information. They consider what it would cost to build the improvements on that land and then appreciate it, making adjustments for the fact that a new building is not an exact replica of what’s currently there.

Since there are differences, you need to measure those differences:

• Physical depreciation refers to the physical wear and tear of an asset.
• Functional obsolescence refers to outdated features that impact the building’s value or usefulness. For instance, a building may have outdated wiring that decreases its value.
• Economic obsolescence refers to the loss of value in a piece of property as a result of unfavorable economic factors. An example of this today is the rise of remote work. This has lessened the demand for office space, which means you may not be able to charge as much for leases or you wouldn’t build the space the same way if you were to rebuild today.

By considering these differences, quantifying them, and building a case to support them, you could very well reduce the value of real property as compared to an assessor’s initial determination.

The cost approach is best for valuing personal property because these types of assets are unique. Whether you’re valuing specialized assets (like machinery and equipment for manufacturing or fiber-optic cables being used by a broadband company) or more traditional items like inventory, computers, and desks, the cost approach presents the simplest, most accurate valuation method.

First, you determine what it would cost to replace the item today. Then you make similar adjustments as mentioned above for real property, including physical wear and tear and economic and functional obsolescence.

For business personal property, these adjustments will primarily impact outdated technology or machinery — assets that, many years later, might not work as well as a new replacement or perhaps only produce half of what they were originally intended to. Things to look out for:

• Assessors rarely take obsolescence of any kind into consideration. They tend to use standard depreciation tables and minimal subjectivity. For example, many assessors would say computers depreciate faster than machinery. But they don’t take into account that an asset is broken or obsolete in any way — unless you ask for it. Bringing these issues to light helps ensure that a company’s assets are not assessed higher than their fair market value.
• Be aware that, very often, assessors not only depreciate your cost but also inflate it. Take the case of the computer. If they believe that replacing the computer today would cost more, they’ll inflate it first then depreciate it. That means the computer you paid $1,000 for two years ago could still be on the books for $1,000 now. It may end up that your values are equal to your costs.

Why is the cost approach best for personal property? On occasion, you can find similar transactions, and if there are a lot and the data is prevalent, then you can use the market approach. But in many cases, it’s difficult to find.

On some occasions, you may also be able to use the income approach, but the complexities posed by trying to apply this method to personal property make it difficult. The income approach encompasses nearly everything about a business — the building, the land, customer relationships, and even the brand on the door. It’s extremely challenging to isolate only the values of personal property without the rest of the elements involved.

Plus, many businesses have intangible value, such as a brand or a loyal customer base (think luxury brands). In many jurisdictions, these are intangible assets that are not taxable.

For these reasons, many property tax professionals tend to use the cost approach for personal property.

There are three approaches to choose from when it comes to charging your clients for property tax valuation services:

1. If the work is being done on an ad hoc advisory basis and the scope of work — as well as the level of your involvement — is unclear, an hourly arrangement is best.
2. If the scope of work and the deliverables are clear, and you have a process in place to do the work, then a fixed fee is the typical approach.
3. If you’re just beginning to offer this service, your clients may be unsure of how beneficial it will be for them, making them hesitant to pay either a fixed fee or an hourly rate. In this case, it’s best to offer the option to pay as a percentage of the savings. If a company’s tax bill is reduced by $50,000 as a result of the valuation advice provided by your accounting firm, then both parties would share in that savings. The amount of the split will vary — anywhere from 10% to 50% — depending on the opportunity, the size of the savings, and the breadth of your involvement.

Fixed fees are usually preferable for both you and your client. Your firm will always have a clear view of what’s coming in, and fixed fees make it easier to scale up. It’s also easier for clients to understand the cost of the service (especially if it’s in the early days of your offering where this territory may still be a bit murky).

Aside from property tax, property valuation is also used in other scenarios, such as financial or tax reporting, or transactions. For example, if a business recently purchased a property and is required to do a purchase price allocation, you can use these methods to break apart and value intangible assets, tangible land, buildings, and personal property. Activities like these can be complementary to property tax — and you can use the result for property tax filings.

Or vice versa — if you’ve built a staff that’s capable of doing those types of valuations, then you can offer both services across the board.

For an accounting firm looking to better support their clients, property tax valuation is a valuable service — one that helps ensure your clients receive appropriate, fair tax bills at the end of every year.

Property tax compliance services are just as important, and also present savings opportunities. Filing accurate and timely returns and paying bills on time avoids costly mistakes and penalties. You can easily scale up your services in both areas with the help of software such as Avalara Property Tax Returns Pro and Avalara Property Tax for Enterprise.

Both solutions have automation features that streamline property tax management, helping you more easily manage the data, deadlines, and filing requirements in every jurisdiction. They also support large volumes of work to meet demanding workloads, setting you up for success with your new offerings.  Contact our property tax compliance specialists to learn how Avalara can help.