Removing Intangible Assets from a Property Tax Assessment: the "rushmore Method" Really Has Been Rejected in California

• Jurisdiction: California,United States
• Author: By C. Stephen Davis
• Citation: Vol. 28 No. 3
• Publication year: 2020

Removing Intangible Assets from a Property Tax Assessment: The "Rushmore Method" Really Has Been Rejected in California

By C. Stephen Davis¹

Intangible assets are exempt from property tax assessment in California.² Some methods of removing the value of such exempt assets from assessed values have been controversial. A recent article in this publication asserts that "California law is unsettled" on the issue of whether deducting "franchise and management fees as an expense from [a hotel's] operating income completely removes the value of intangible assets which contribute to that income."³ The "method" of removing intangible assets from an income indicator by subtracting expenses relating to such assets from projected income is known as the "Rushmore Method." The California Court of Appeal rejected use of the Rushmore Method for California property tax purposes in SHC Half Moon Bay v. County of San Mateo.⁴ Yet, some continue to assert that SHC does not hold that the Rushmore Method was infirm for purposes of California property tax, or that case should simply be limited to its facts and establishes no ruling of general application. This article demonstrates that SHC did in fact consider and reject the Rushmore Method, and that doing so was consistent with well-founded and longstanding California authority. California law is not unsettled on this issue.⁵

Exempt intangible assets are frequently subsumed in property tax assessments. This occurs because assessors use appraisal methods that necessarily include such assets, but then fail to the take the secondary steps required to remove the value of such exempt assets from the assessed value. Omitting the critical second step renders the resulting assessment void.

Examples of the common appraisal methods that necessarily include the value of exempt intangible assets include enrolling the purchase price of a business that includes both tangible and intangible assets, using sales of businesses or leased fee interests as comparable sales or capitalizing the net operating revenue stream of an enterprise using the income approach (going concern value). Each of these methods includes the value of exempt intangible assets that must be removed from the resulting value indicator prior to assessment.

Segregating the tangible and intangible assets is essential for purposes of California property tax because businesses are not assessed as such; instead, only the tangible property (land, buildings, fixtures, equipment and personal property) owned or used by the business is assessed. (A "business" does not escape taxation. A business is, in effect, taxed indirectly by means of the income tax, payroll taxes, business license taxes and the like.) This critical distinction can be illustrated by a medical office building. If several doctors own the building in which they practice, an assessor does not capitalize the revenue earned by the doctors treating patients to establish the value of the building, because doing so would establish the value of the medical practice and not the building. The value of just the land and building would be established by capitalizing rent based on market rents of comparable buildings, or establishing the value of the land based on land sales and adding the estimated cost of building the medical offices, or from the sales prices of comparable buildings, plus the depreciated cost of equipment. The "enterprise value" or "going concern" value of the medical practices is not assessed.

In the case of a hotel, if net room fees, restaurant and bar charges, laundry fees and the like are capitalized, then the income indicator reflects the economic contribution of all the intangible assets that contribute to the capitalized income stream, as it would for any lodging enterprise, restaurant, bar or dry cleaner (the revenue from which would never be used to value the real or personal property of such businesses). Thus, different valuation methods or additional steps must be taken to segregate the value of the hotel business from the value of the land, buildings, fixtures and the like. For the larger more complex hotels, the segregation process is complicated by the fact that such properties rarely rent and are usually sold as an operating hotel business. The sales prices therefore typically represent "going concern value," i.e., the value of a business, and so if sale prices of operating hotels are used for appraisal, or if net operating income is capitalized, then additional steps must be taken to remove the value of the exempt intangible assets from the business value.

[Page 32]

This is where the appeal of the Rushmore Method comes in. Having selected an appraisal method that subsumes intangible assets, instead of using a cost approach which does not, the burden to segregate the taxable and exempt intangible assets falls on the Assessor.⁶ Doing so requires a great deal of technical work. But the Rushmore Method purports to relieve assessors of the onerous task of identifying, valuing and removing the value of intangible assets. The Rushmore Method posits that deducting franchise fees and management fees, a standard step in all hotel income approaches, automatically removes all the value of the exempt intangible assets has been automatically removed. Under this theory, an income approach, even one based on business operating income, does not subsume business value or other intangible assets—unlike the medical practice example above. Hence, no further segregation step is required.

How does this counter-intuitive outcome arise? What intangible asset values are removed? How is the value of an assembled and trained workforce, or the value of the restaurant, event venue, spa businesses and liquor licenses removed from the indicated value? No explanation exists. The Court of Appeal in SHC correctly observed: "We disagree with the County's claim that 'the intangible value was removed by deducting the management and franchise fee. . . .' The Assessor removed the management and franchise fee from the...