Real and personal property tax incentives: the often-overlooked tax benefits.

• Author: Lohman, Janette M.

There is currently much competition among states for in-bound corporate economic development opportunities. Admittedly, tax and other financial incentives usually are not the primary reasons a business decides to expand in or relocate to a particular location. The availability of an educated workforce, access to transportation and distribution networks, and other business considerations take precedence over the availability of tax breaks. All other factors being equal, however, the amount of economic assistance state and local governments are willing to provide to the business may determine final site selection.

While states are quick to tout the availability of income tax credit incentive programs, states do not always advertise the availability of local real and personal property tax abatements, exemptions, or other property tax relief. As a result, an expanding business might overlook property tax incentives in its site selection analysis. More important, property tax incentives might prove more lucrative than income tax credits, because the vast majority of state-sponsored income tax credit programs do not provide guaranteed benefits. Income tax credit programs can be riddled with limitations preventing otherwise qualifying businesses from utilizing earned credits. The most common limitation is that tax credits may only offset income tax liabilities generated at the new location. Some of the income tax credit programs are "use it or lose it"; to the extent that the business cannot utilize all or part of the income tax credits for the year earned, the business loses the benefit. Most income tax credit programs mitigate this hazard by providing carryforward periods to permit the business to utilize unused credits in future years, but very few income tax credit programs guarantee such utilization by refunding unused credits or permitting the businesses to sell unused credits to other taxpayers. (1) If the new business owes little or no income tax during the credit program's award year or carryforward period, the business stands to lose some or all of the economic benefit that the state has promised. Once a business has been granted real and personal property tax incentives, however, almost all incentives will directly offset property tax expenses that the business would otherwise have to pay, regardless of whether the business ever makes a taxable profit. Thus, if a business receives a property tax abatement or other reduction in its property tax liability, the business will actually receive the benefits that the government has promised.

More states are permitting local governments to offer property tax incentives as an inducement to businesses to restore historic properties or move to or expand within their boundaries. By the end of 2001, more than half of the states permitted local governments to provide property tax relief for the restoration of historic properties or permitted real or personal property tax incentives to expand within their boundaries.

In spite of the increasing availability of expansion-related property tax incentives, state income tax credit programs continue to get most of the attention. Economic development agencies in many states go to great lengths to advertise and promote the availability of their income tax credit programs. States have political reasons for not advertising property tax incentives because those programs are generally administered at the local level and states may not want to get in the middle of competition for the new business among their own local governments.

In addition, many state and local governments have pressing financial reasons to keep property tax incentives in the closet. Income tax credits are really not expensive from the states' standpoint because there is a chance that the business will not be able to utilize all of the credits and, even if all the credits are utilized, the lost income tax revenues will be more than offset by the other types of state taxes that the new businesses will pay. A temporary, one-time decrease in a state's corporate income tax revenues over a short period of years will be more than replaced in the long run by permanent increases in state withholding taxes, sales and use taxes, future income taxes, and other business taxes that the business will pay. By contrast, most property tax benefits are granted at the local level in the form of longer-term tax abatements, exemptions or other tax reductions that the new business would otherwise have to pay. Unlike the states, counties and cities have very few alternatives to recoup lost property tax revenue. As a result, state and local governments may not want to publicize the availability of these incentives to new and expanding businesses unless the incentives are absolutely necessary to attract the new businesses into the area.

This article shines much-needed light on the types of real and personal property tax incentives that may be available to new or expanding businesses. After identifying the different types of property tax incentives that businesses should seek, the article outlines common traps to avoid in negotiating these property tax incentives during the site selection process.

Types of Property Tax Incentives--Preliminary Considerations

1. Low Property Tax Rates

   Because state and local governments offer property tax incentives in many different forms, it can be difficult to determine which local government is offering the best deal. To make a valid comparison, the business should compute each site finalist's property tax, net of the incentives offered. For instance, assume that two cities are competing for an industrial expansion. City A offers the new business a 50-percent property tax abatement for 20 years and City B offers no property tax incentives whatsoever. Is this too easy? Not so fast. Although a 50-percent tax abatement for 20 years sounds terrific, it might not be a good deal if City B's overall property tax rate is less than 50 percent of City A's tax bill, net of City A's incentives. (2) In this example, the added benefit is that the new business will not have to go through the tax abatement/exemption application process to receive the lowest property tax expense in City B. Now that is an incentive!

2. Percentage Reductions vs. Negotiated Benefits

   Many real and personal property tax incentives take the form of either a low assessment percentage or an absolute abatement of all or part of the property, generally for a fixed period of years. Sometimes the incentive will be a statutory right applicable to all property within a particular classification and often the business must negotiate both the amount of the incentives and the number of years that the property will qualify for the benefit. With respect to negotiated benefits, care should be taken to avoid fixed dollar reductions in actual tax liability. If the reduction takes the form of a reduced percentage of the assessed value or the tax rate, businesses will receive proportionate additional reductions if the local government raises the tax rates in future years. In contrast, if the business negotiates a fixed dollar reduction per year in the business's total property tax liability, there is nothing to stop the local government from increasing the tax rate so that in subsequent years, the taxpayer pays more property taxes than originally anticipated!

   Types of Property Tax Incentives

1. Property Tax Incentives for Historic Preservation

   Many businesses are choosing to relocate or expand into renovated, historic buildings. The governmental justification for providing special tax relief for the rehabilitation of historically significant structures is that local governments have an interest in preserving structures representing important periods or events in their heritage. Unfortunately, it is generally easier and cheaper for a business to demolish an old building and erect a new one than it is to refurbish the old one in accordance with established historic standards. In order to supplement federal and states' income tax credit programs for the rehabilitation of qualifying historic structures, (3) at least 31 states now offer supplemental real property tax relief for historic structures. (4)

   Historic property tax relief programs range from statewide programs to benefits that are only offered if the relevant local government decides to grant them. Most, but not all, of these programs require the developer to adhere to the federal rehabilitation standards published by the U.S. Secretary of the Interior. Other jurisdictions require the developer to use renovation standards that are based on local determinations of historic merit and/or the age of the property being renovated.

   The most common type of historic property tax incentive is an abatement or exemption for the value of all improvements made to the structure. More than one third of the states' historic programs "freeze" the assessed value of the historic property at its pre-rehabilitated value for a period of time ranging from as low as 4 years (Iowa) to as long as 15 years (Tennessee). Others provide an abatement for only a portion of the rehabilitation expenditures (e.g., California and North Carolina abate only 50 percent of the improvements). Some of the states provide graduated "phase-in" periods at the end of the abatement periods to lessen the burden of the historic property's being eventually subject to tax on its full-assessed value. Other states provide a statutory preferential assessment percentage for qualifying historic properties. For example, Alabama provides a 10-percent assessment ratio for historic properties compared with South Carolina's 60-percent assessment rate for commercial properties.

   Caution: Remember the warning about computing tax liabilities net of benefits. Alabama's permanent 10-percent assessment ratio may produce better overall results than some of the other states' provisions providing for a 100-percent...