Understanding Intangible Assets and Real Estate: a Response to the Iaao Committee's Guide

• Publication year: 2018
• Author: By Cris K. O'Neall & C. Stephen Davis

Understanding Intangible Assets and Real Estate: A Response to the IAAO Committee's Guide

By Cris K. O'Neall & C. Stephen Davis¹

This paper responds to the guide issued by the IAAO Special Committee on Intangibles relating to the handling of intangible assets and real estate in property tax valuation and assessment. The response supports use of appraisal methods which directly appraise and remove the full value of identified non-taxable intangible assets in the valuation and assessment of taxable real property. The response also addresses some of the methods discussed in the IAAO Committee's guide and identifies concerns with the legal authorities cited in the guide.

In early 2017 the International Association of Assessing Officers (IAAO) Special Committee on Intangibles issued a white paper addressing the scope of the intangible asset exemption: "Understanding Intangible Assets and Real Estate: A Guide for Real Property Valuation Professionals,"² hereafter the "IAAO Guide" or "Guide." The IAAO describes the purpose of the IAAO Guide as follows: "This guide is intended to assist assessors in understanding and addressing intangible assets in property tax valuation" and "to assist in identifying intangible assets and exclude them from real property assessments." ³ The Guide purports to describe the legal and appraisal requirements for removing the value of intangible assets and rights in the assessment of real estate for property tax purposes. However, the Guide advocates appraisal methods that do not remove the value of intangible assets from assessment, omits essential appraisal authority, mis-cites court decisions, and ignores controlling law. This paper exposes the unbalanced nature of and errors in the Guide, including techniques which purportedly minimize or eliminate the value of intangible assets from assessment and other omissions.

I. THE QUALIFIED NATURE OF THE IAAO GUIDE

Not all IAAO publications have equal weight. The IAAO Guide expressly provides the following self-limiting disclosure immediately below the title of the paper: "This guide was developed by the IAAO Special Committee on Intangibles for informational purposes only and does not necessarily represent a policy position of IAAO. This guide is not a Technical Standard and was developed for the benefit of assessment professionals."⁴

An IAAO "technical standard" represents an official position of the IAAO: "International Association of Assessing Officers (IAAO) maintains technical standards that reflect the official position of IAAO on various topics related to property tax administration, property tax policy, and valuation of property including mass appraisal and related disciplines. These standards are adopted by the IAAO Executive Board. IAAO assessment standards represent a consensus in the assessing profession."⁵ The IAAO Guide is not an IAAO technical standard, so it has not been approved by the IAAO Executive Board and cannot be described as endorsing a "consensus" in the assessing profession.

II. EXCLUDING THE VALUE OF INTANGIBLE ASSETS: ISSUES RAISED IN THE IAAO GUIDE

The IAAO Guide correctly acknowledges that in "the majority of jurisdictions, intangible assets are not taxable, at least not as part of the real estate assessment. As a result, assessors must ensure their real estate assessments are free of any intangible value" and that "the value of intangible assets is excluded." The Guide also says "assessors seek methods that measure the value of the real property but exclude any intangible asset value" and "[assessors] must utilize methods to ensure the value of intangible assets is excluded from real estate assessments."⁶

The question is whether the IAAO Guide actually proposes methods that meet this standard. The bare assertion that all of the intangible assets have been removed from an assessment must be tested: if the appraisal methodology is recognized to encompass non-taxable intangible assets, then it must demonstrate exactly how intangibles are removed and what value was ascribed to each of those removed intangibles. The methods advocated by the Guide can be evaluated by asking whether a particular method of appraisal subsumes intangible assets and, if so, what those intangibles are, their values, and whether those values are actually excluded.

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A fundamental question raised by any assessment or appraisal method is whether it is likely to include intangible assets. Capitalizing operating revenue very likely means that business enterprise, and/or business enterprise components such as assembled workforce, working capital, licensing rights or such, are included in the assessment. If the cost indicator includes a line item for operating permits or environmental emission credits, then an intangible asset is being assessed. If the sales price is paid for a rental property, and that price is based on an above market lease in place and/or fails to account for lease-up costs and delay, then intangible assets are implicated. Thus, an initial question is whether the nature of the property at issue and the appraisal method implicates intangible assets.

There are a number of issues addressed in the IAAO Guide which are accepted in the appraisal profession as being consistent with correct methods for handling the identification, segregation and removal of intangibles. For example, several paragraphs in the Guide point out that the Cost Approach, as applied to the tangible real and personal property, "inherently excludes" the value of non-taxable intangible assets and rights.⁷ The Guide also states that when the Sales Comparison Approach or the Income Approach are used to value going-concern type properties, it is likely that non-taxable intangibles are subsumed in the going-concern value conclusion, and those intangibles that were captured need to be identified and their values excluded.⁸ In addition, the Guide cautions that sales prices for real property sold along with a business may include intangibles' values.⁹ Therefore, from an introductory perspective, the Guide satisfactorily identifies those situations in which intangibles may be implicated in an appraisal.

There are other issues addressed in the IAAO Guide which are not accurately or correctly discussed. The first is the "separability" criteria for identifying intangibles. The second is the role of ownership in the intangibles exclusion process. The third is the use of accounting and tax records to allocate value to intangible assets. And the fourth is the efficacy of the Rushmore "Management Fee" method for removing the value of non-taxable intangibles. Each of these issues is addressed below.

A. Separability Is Not Necessary for the Identification of Intangible Assets 1. The Issue

The IAAO Guide asserts that "separability" is necessary for identification of intangibles because some intangible assets are "intertwined" in that one intangible is dependent upon another and the intangibles "are not easily separated." The Guide also states "the question is whether the business . . . could be separated from the real estate" or, more broadly, "[i]f the real estate [could] be sold without the intangible."¹⁰

2. The Response

An intangible asset need not "be capable of being separate and divisible from real estate" as the IAAO Guide contends for the intangible to be recognized, and the "separability test" is unnecessary. No reason is given for separability in the IAAO's list of requirements for identifying intangibles. In fact, so long as there is adequate data available for placing a value on an intangible, even one that is not easily separated from real estate, the ability to divide the intangible from the real estate is irrelevant.

California's State Board of Equalization (SBE) addressed the issue of "separability" when it approved Assessors' Handbook Section 502 in December 1998.¹¹ In Issue Paper Number 98-031, which was released prior to approving Assessors' Handbook Section 502, the California SBE considered the question of separability.¹² On December 7, 1998, the California SBE's Property Tax Committee determined that separability was not necessary in order to recognize an intangible asset or right for purposes of removing the intangible's value in the property tax assessment of taxable real and personal property.¹³ Based on this decision, the California SBE included language in Assessors' Handbook Section 502, Chapter 6 (entitled "Treatment of Intangible Assets and Rights") stating that while some intangible assets and rights may be identifiable but not capable of segregation, the inability to separate an intangible "does not prevent recognition of the value" of the intangible.¹⁴ The California SBE's guidance is consistent with that of Reilly and Schweihs issued ten years later: "[T]here is absolutely no requirement that the intangible asset has to be transferable separately from other assets. In other words, the subject commercial intangible asset may be sold with other tangible assets and/ or with other intangible assets."¹⁵

The IAAO Guide is unclear about what types of intangibles must be found separable. The example provided is the "historical significance" of the WaldorfAstoria Hotel in New York City.¹⁶ The Guide then refers to other types of "real property attributes" that are intangible in nature and cannot be sold without the real property, such as view, proximity (location), prestige and appeal.¹⁷ Later, the Guide refers to "real property intangibles" such as zoning and air rights.¹⁸ All of these intangible attributes of real property are properly tied to the real property because they are integral to the property (just as a property's layout, design, or architectural style is integral to the property). These intangible real property attributes are taxable under California Revenue and Taxation Code section 110(f) and the California Supreme Court's guidance: "[I]ntangible attributes of real property" include location, proximity, zoning, view, architecture and other...