Intangible Property and Property Tax Appraisals

Part III of III

This article is the third and final of a three-part series on intangible property and property tax appraisals. Read Part I here and Part II here. Valuation analysts are often retained by industrial and commercial companies to assist with state and local property tax planning, compliance, and controversy matters. Often, analysts are retained by the legal counsel for the corporate taxpayers. This is particularly the case when the property tax matter involves an assessment appeal or litigation regarding the amount of the property assessment. The articles in this series focus on the valuation of intangible property within the context of ad valorem property tax disputes.

Introduction

Valuation analysts (“analysts”) are often retained to assist utility-type industrial and commercial taxpayers with ad valorem property tax planning, compliance, and appeal matters. State and local property tax assessors often apply the unit principle of property appraisal to value the taxable property of such utility-type industrial and commercial taxpayers.

The unit principle appraisal conclusion typically includes the value of both (1) taxpayer’s total tangible property and (2) the taxpayer’s total intangible property. However, in many taxing jurisdictions, intangible property is exempt from state and local property taxation. Therefore, analysts are often retained (by the taxpayer or taxpayer’s counsel) to extract the value of any exempt intangible property from the taxpayer’s total unit value.

Tax assessment authorities often object to the analyst’s valuation of the taxpayer’s exempt intangible property. This discussion summarizes the most typical of these states and local tax assessor objections. And, this discussion recommends analyst best practices responses to these typical taxing authority objections.

Typical Tax Assessor Objections to Intangible Property Valuations

State and local tax assessors may object to the analyst’s identification of exempt intangible property in the taxpayer’s unit valuation. These assessment authorities may object that the identified property (1) is not, in fact, intangible personal property or (2) is not, in fact, exempt from property taxation.

These assessment authorities may object to the analyst’s valuation of the exempt intangible property in the taxpayer’s unit valuation. These authorities may object that (1) the concluded value is misstated or (2) the intangible property cannot be valued at all.

And, these assessment authorities may object to the extraction method applied by the analyst to remove the intangible property value from the taxpayer’s total unit value. These tax assessors may (1) reject the analyst’s method as being unsupported and not credible or (2) suggest a method that requires the intangible property to be recorded on the taxpayer’s balance sheet.

Table 1 lists 10 of the typical tax assessor objections to the intangible property valuation and extraction process. This list is not intended to be comprehensive.

Table 1: Tax Assessor Typical Objections to Intangible Property Valuations

• You cannot sell intangible property separately from the unit, so intangible property has no value.
• You cannot subtract intangible property appraised by one valuation approach from a unit value appraised by a different valuation approach.
• Apply the cost approach to value the total unit. That unit valuation approach does not include intangible property value.
• You cannot have intangible property and economic obsolescence within the same total unit.
• Intangible property values are not stand-alone fair market values; but, rather, contributory values to the unit.
• Intangible property (especially assembled workforce) is not recorded on the taxpayer’s balance sheet.
• Intangible property can only be valued by reference to a market value/book value ratio.
• You need tangible property to contribute to intangible property income.
• Intangible property value just captures a portion of the total unit value.

The following discussion recommends analyst best practices responses to each of these tax assessor typical objections.

You Cannot Sell Intangible Property Separately

There is no appraisal or accounting requirement that intangible property must sell separately from tangible property to qualify as an intangible property. The intangible property should be transferrable. That does not mean that the intangible property should be transferable independently from any other property. As mentioned above, GAAP guidance is very specific with regard to the issue of intangible property transferability—intangible property may sell with tangible property and/or other intangible property.

Analysts value all unit property (both tangible and intangible) as part of the total unit; assuming that the total unit sells. Analysts do not value tangible property assuming it sells separately from the unit. For example, an analyst would not appraise the ballast, the ties, or the rails separately from the total unit of a taxpayer’s railroad operations.

This “intangible property must be sold separately” tax assessor typical objection violates:

• The unit valuation principle of property appraisal
• The HABU of the total taxpayer unit
• Both USPAP and UASFLA valuation professional standards

You Cannot Subtract One Approach from Another Approach

Many taxing jurisdictions allow exemptions from the total unit value for property types such as the following:

• OTR vehicles
• Locally assessed property
• Pollution abatement equipment
• Other property categories

When these exempt property categories are removed from the taxpayer total unit value, each of these property categories is typically valued by reference to one valuation approach. The typical valuation method that is applied by many taxing jurisdictions is a HCLD method (or a market value to book value ratio method). In these taxing jurisdictions, these exempt property category values are subtracted from the reconciled total taxpayer unit value. This is the fundamental principle of applying this exempt property value adjustment:

Value of the total unit

–     value of the exempt property

=     value of the taxable property

There is no appraisal or accounting principle that requires exempt property values to be subtracted from within each individual unit valuation approach.

Apply the Cost Approach to Value the Total Unit

There are numerous issues related to this assessment authority recommendation. First, sole reliance on the cost approach excludes consideration of all income approach and market approach unit valuation methods in the total unit valuation. Sole reliance on the cost approach also ignores the valuation approach that is principally relied on by market participants—the income approach.

The primary concern with this objection is that sole reliance on the cost approach does not eliminate consideration of intangible property value in the unit principle valuation. That is because, as described earlier in this series, intangible property value should be considered in any cost approach economic obsolescence measurement analysis.

In addition, the consideration of intangible property value is a fundamental procedure in all generally accepted property appraisal standards. In particular, the USPAP valuation professional standards require the separation of intangible property value from tangible property value in any property appraisal.

Intangible Property and Economic Obsolescence in the Same Unit

If there is economic obsolescence experienced in the total taxpayer unit, then all property valued by reference to the cost approach will suffer the same economic obsolescence percentage adjustment. That is, the unit-level economic obsolescence percentage adjustment should be applied to the cost approach value indication for:

• All unit tangible property
• All unit intangible property

Of course, economic obsolescence is implicitly incorporated in all property values concluded from the market approach and the income approach. Therefore, an explicit economic obsolescence adjustment does not have to be applied to any unit property values (i.e., tangible property values or intangible property values) concluded from either the market approach or the income approach.

Economic obsolescence indicates that the total taxpayer unit is suffering from some measure of income deficiency. It is a correct conclusion that if economic obsolescence exists, then no unit property (either tangible or intangible) should be valued by reference to a capitalized excess earnings valuation method.

It is important for analysts to recall that the total taxpayer unit (including a unit experiencing economic obsolescence) encompasses a number of property categories, including:

• Working capital
• Real estate
• Tangible personal property
• Intangible personal property
• Regulatory and other property

Therefore, all of these property categories should be considered in any unit-level economic obsolescence measurement analysis. And, the unit-level economic obsolescence adjustment should be applied to every property category that is valued through the application of the cost approach.

Intangible Property Values are Contributory Values to the Unit

In a unit principle valuation, all property values are contributory values to the unit. This statement is as applicable to tangible property as it is to intangible property. In fact, this statement represents the fundamental premise of a unit principle property valuation.

The fundamental premise of any unit principle property valuation is: the entire unit of property sells at one time from a willing seller to a willing buyer. That is, all property categories (all tangible property and all intangible property) transfer in a total unit sale transaction. The tangible property does not sell separately. The intangible property does not sell separately. And, all property (tangible and intangible) contributes to the overall unit value.

Intangible Property Not Recorded on Taxpayer’s Balance Sheet

Under U.S. GAAP, intangible assets are generally not reported on a taxpayer company’s balance sheet unless they are acquired in a business combination transaction. Then, the acquired intangible assets are reported at fair value; not at fair market value. Under GAAP, some intangible assets (including the trained and assembled workforce) are not recorded separately from the acquired goodwill in a business combination transaction. However, analysts should note that an acquired assembled workforce is reported (at fair market value) separately from goodwill on an income tax balance sheet as a Section 197 intangible asset. This is one example of why a taxpayer’s GAAP balance sheet may be different from a taxpayer’s income tax balance sheet after a merger or acquisition transaction.

Analysts should also note that an acquired assembled workforce is reported on a GAAP balance sheet in certain transaction structures (for example, in an asset acquisition that is not reported as a business combination). In a business combination transaction, the assembled workforce is valued as part of the purchase price allocation analysis to ensure that the residual goodwill measurement is at least as large as the assembled workforce fair value. There is Appraisal Foundation, Certified in Entity and Intangibles Valuation, Financial Accounting Standards Board, International Valuation Standards, and other authoritative guidance that has been promulgated regarding the assembled workforce valuation.

Whether or not an intangible asset category is reported on the taxpayer company’s balance sheet, intangible property is property that contributes to the value of the total taxpayer unit. There is no appraisal requirement that intangible property should be reported on a taxpayer’s balance sheet in order for that intangible property to be recognized for unit valuation purposes.

Intangible Property and the MV/BV Ratio

Frist, the application of any market value to book value ratio assumes that the total unit market value is correctly estimated. Second, the obvious problem with this so-called intangible property valuation procedure is: there is typically no accounting book value for the taxpayer’s intangible property.

As described above, intangible property is only reported on a GAAP balance sheet after a business combination (a merger or acquisition) transaction. If the taxpayer unit was not recently acquired, then there will be no intangible property book value reported on the taxpayer’s GAAP balance sheet. After an acquisition that is accounted for as a business combination under ASC topic 805, the reported intangible property fair value is tested periodically for impairment. This fair value impairment test is described in the provisions of ASC topic 350 Intangible–Guidance and Others. Under the provisions of ASC topic 350, the reported intangible property book value can never be restored (i.e., increased) even when the intangible property fair value has been restored.

Therefore, lack of a reported accounting book value for most internally developed intangible property simply invalidates the use of a MV/BV ratio procedure to value the intangible property included in the unit valuation.

Intangible Property is Not Property

As explained above, the question of what is (and what is not) property is a legal (not an analyst) issue. The question of what is property, is a matter of state (sometimes federal) statute. Analysts estimate the value of property (unit value, tangible property value, intangible property value). Analysts do not determine the legal status of property.

As described above, intangible attributes and/or intangible influences typically do not have the legal elements of property. However, analysts recognize that there are numerous categories of intangible property that do have the legal elements of property.

Some states may not recognize certain definitions of business goodwill as property. Again, there are numerous categories of intangible personal property that are legally recognized (and legally protected) as property. Analysts focus on these property categories when concluding the taxpayer’s taxable unit of property.

You Need Tangible Property to Contribute to the Intangible Property Income

Typically, the taxpayer unit will need tangible property to contribute to the intangible property income (and value). Typically, the taxpayer unit will also need intangible property to contribute to the tangible property income (and value). That is, both tangible property and intangible property are needed to contribute to the total unit income (and value). All tangible property and all intangible property have a contributory value that collectively results in the taxpayer’s total unit value.

All property categories (both tangible and intangible) represent a portion of the taxpayer’s total unit. All tangible property values and all intangible property values represent a portion of the taxpayer’s total unit value.

All unit property categories are needed to operate the total unit. These unit property categories include the following:

• Working capital accounts
• Real estate
• Tangible personal property
• Intangible property
• Regulatory and other property accounts

All unit property categories contribute to the taxpayer’s total unit value.

Other Tax Assessor Objections to Intangible Property Extraction

In addition to the above-listed principal objections to intangible property identification and valuation, taxing authorities often suggest other objections to extracting intangible property value from the total unit value.

Some of these additional tax assessor objections are listed in Table 2. Table 2 is not intended to be comprehensive.

A specific response to each of these other assessor objections is beyond the scope of this discussion. However, analysts should understand that there are also best practices responses to each of these other tax assessor objections to intangible property valuations.

Table 2: Other Tax Assessor Objections to Intangible Property Valuations

1. Intangible property is the same as going concern value. Analysts value the total unit on a going concern basis. Analysts value the tangible property on a going concern basis. Intangible property value is the same as unit value which is the same as tangible property value.
2. There is no single generally accepted list of intangible property.
3. Every taxpayer in this taxing jurisdiction owns some intangible property. The subject taxpayer (or taxpayer unit) is not unique.
4. The taxing authority does not have the time, data, or expertise to value each taxpayer’s exempt intangible property.
5. If the taxing authority “gives” an intangible property exemption to this taxpayer, then it will have to “give” an intangible property exemption to every similar taxpayer.
6. This taxing assessor just does not believe in intangible property.
7. The taxing assessor does not “see” any intangible property.
8. The tax assessor did not add any intangible property value to the total unit value conclusion; therefore, there is nothing to extract.

In responding to these other objections, taxpayers and analysts should note that some taxation authority representatives may have no experience or expertise with regard to the intangible property valuation. In addition, taxpayers and analysts should note that some taxation authority representatives may have no experience or expertise with regard to GAAP accounting issues. These factors should be considered when the taxpayer and/or analysts crafts a response (formal or informal) to any of these other tax assessor objections.

Summary and Conclusion

This discussion concludes a three-part series. This series considered what valuation analysts need to know about the valuation of intangible property within an ad valorem property tax context.

State and local taxing authorities often apply the unit principle of property valuation to value the taxable property of utility-type industrial and commercial taxpayers for ad valorem property tax purposes. Depending on the unit valuation approaches and methods applied and on the specific valuation variables selected, the total unit value conclusion may include various property categories. Some of these property categories (including intangible property) may be exempt from property taxation in the subject taxing jurisdiction.

This discussion series focused on (1) the identification and valuation of intangible property within the total unit value and (2) the extraction of that intangible property value from the total unit value to conclude that taxable unit value. Specifically, this discussion series considered the following topics:

• Unit principle valuation definitions and principles
• Unit principle of property valuation standards and procedures
• Identification of intangible property
• Attributes of intangible property
• Generally accepted intangible property valuation standards and procedures
• Generally accepted procedures for the extraction of intangible property from the unit total value

This series presented an illustrative example of a typical intangible property extraction method. And, this series recommended analyst best practices responses to tax assessor typical objections regarding intangible property valuations.

Analysts, taxpayer’s, and tax assessors should all be aware of the issues related to intangible property (and any other exempt property) valuation in the development of a unit principle valuation for state and local property tax purposes.

The opinions and materials contained herein do not necessarily reflect the opinions and beliefs of the author’s employer. In authoring this discussion, neither the author nor Willamette Management Associates, a Citizens Company, is undertaking to provide any legal, accounting or tax advice in connection with this discussion. Any party receiving this discussion must rely on its own legal counsel, accountants, and other similar expert advisors for legal, accounting, tax, and other similar advice relating to the subject matter of this discussion.

---

Robert F. Reilly, CPA, ASA, ABV, CVA, CFF, CMA, is a retired former Managing Director of Willamette Management Associates. He lives in Chicago and continues to consult in areas of his previous practice that included business valuations, forensic analysis, and financial opinion service.

Mr. Reilly can be contacted at (847) 207-7210 or by e-mail to robertfreilly.cpa@gmail.com.