Property Tax Counsel Considerations When Choosing a Unit Principle Property Appraisal Analyst (Part III)

Property Tax Counsel Considerations When Choosing a Unit Principle Property Appraisal Analyst (Part III)

Connor J. Thurman, ASA, ABV

State and local property taxation legal counsel may become involved in matters related to a dispute surrounding certain taxable properties owned by their corporate clients. Some of these disputes may involve property that is assessed centrally under the unit principle of property assessment. In such matters, legal counsel may require the professional assistance of an appraisal analyst experienced in unit principle property appraisal. In such instances, there are numerous considerations that legal counsel may make when choosing such an appraisal analyst.This article is the third in a four-part series describing considerations that legal counsel may make when choosing an appraisal analyst in a unit principle property appraisal context. This part of the series focuses on the review of the unit principle property appraisal report.

Appraisal Report Review

An important consideration when choosing the analyst is that counsel understands the analyst’s work product (i.e., the appraisal report).

The first step of counsel’s understanding of the analyst’s appraisal report is a review of the planned appraisal process. Counsel and the analyst should discuss the due diligence and analyses that the analyst expects to perform to reach the appraisal conclusion.

For example, counsel may consider whether the analyst plans to perform a due diligence interview of the taxpayer company management during the appraisal assignment. Due diligence interviews are often conducted to:

1. understand the nature and operating history of the Total Unit (and the Subject Property) and
2. discuss the historical and (if available) projected financial and operational performance of the Total Unit (and the Subject Property).

Counsel may desire that due diligence interviews take place in-person at the subject taxpayer company’s facilities.  In this instance, the analyst may have the chance to tour the facilities and to inspect the condition of the subject taxpayer company’s property. The analyst’s inspection of the taxpayer company’s property (in particular, the Subject Property) may provide the analyst with important context that can inform appraisal adjustments (such as, value decrements related to physical depreciation and functional obsolescence).

As previously stated, there are generally accepted property appraisal approaches and methods. The analyst typically considers each of the following approaches and methods in a UPP appraisal analysis:

Income approach

 Yield capitalization method

 Direct capitalization method

Market (sales comparison) approach

 Stock & debt method

 Comparable sales method

Cost approach

 Historical cost less depreciation (“HCLD”) method

 Reproduction cost new less depreciation (“RPCNLD”) method

 Replacement cost new less depreciation (“RCNLD”) method

Further, there are also generally accepted intangible personal property appraisal approaches and methods. As previously noted, if the specific appraisal assignment requires the removal of non-taxable property value from the Total Unit value (i.e., to estimate the value of the Subject Property, only), the analyst may apply these approaches and methods.

A simple example of this situation could be expressed as follows:

Subject Property (i.e., property subject to property taxation)

Plus:

Working Capital Assets

Plus:

Intangible Personal Property and Other Assets

Equals:

Total Unit

A discussion of all the generally accepted intangible personal property appraisal approaches and methods is beyond the scope of this discussion.

For each unit principle appraisal assignment, the analyst should consider and select the approaches and methods (1) for which there is a sufficient quantity and quality of data and (2) that is applicable to develop a credible and supportable appraisal of the Total Unit and/or the Subject Property.

A reconciliation and synthesis of the value indications for the applied methods is typically the final procedure of a UPP appraisal. The analysis may be documented in a written or oral appraisal report. As mentioned previously, VPOs commonly issue professional standards related to appraisal reporting. The next section of this discussion summarizes some of the usual contents of, and information sources used in, a written appraisal report.

Total Unit and Subject Property Description

The analyst’s appraisal report should describe and inform the reader of the relevant taxpayer company property, including, for example, the Total Unit and the Subject Property. Usually, the following descriptions are included in an appraisal report:

1. The name of the subject property owner entity
2. The form of the subject property owner entity legal ownership
3. The types of working capital assets, tangible property, and intangible property included in the appraisal analysis
4. The location(s) of the Total Unit, Subject Property, or majority thereof
5. The physical form of the Total Unit and Subject Property
6. The type of interest and bundle of property rights included with the Subject Property being contemplated in the appraisal (e.g., fee simple interest)

Standard, Premise, and Level of Value

The appraisal report should include the standard of value applied in the appraisal. Most UPP appraisals are performed in a property taxation context and typically apply the fair market value standard of value and a premise of value that concludes the highest and best use of the Subject Property.

Different property taxation jurisdictions may rely on slightly different definitions of the fair market value standard of value. However, a common fair market value definition is the price at which a property would exchange between a hypothetical willing and able buyer and a hypothetical willing and able seller, when neither is under compulsion to buy or to sell, and with both parties having reasonable knowledge of the relevant facts.

Further, the appraisal report should conclude the premise of value—or whether the Subject Property was appraised based on the premise of:

1. value in use (i.e., as part of a going-concern), or
2. value in exchange (e.g., as part of an orderly disposition of individual assets and property).

If the analyst did not appraise the Subject Property based on the premise of value in use as part of a going-concern, then the appraisal report should describe the reasoning for performing the appraisal based on an alternative premise of value.

Regardless of the specific premise of value applied in the UPP appraisal, the analyst should confirm that the selected premise of value represents the highest and best use (as that term is defined in USPAP) of the Subject Property.

In a UPP appraisal, the analyst generally concludes a fee simple ownership interest in the Subject Property. If the appraisal subject is something other than a fee simple interest, that fact should be disclosed.

Appraisal Purpose

The appraisal report should include the purpose of the UPP appraisal. Typically, the purpose of the UPP appraisal is to provide an opinion of value of the Subject Property to assist the parties involved the subject tax matter. The appraisal report should clearly discuss the purpose of the analysis so there is no misunderstanding regarding the intended users and use of the appraisal report.

Appraisal Date and Report-Issue Date

The appraisal report should state (1) the appraisal date and (2) the report-issue date. The appraisal date is the analyst’s value conclusion “as of” date for the subject property. The report-issue date is the date that the analyst’s appraisal report is signed and issued.

For example, the appraisal report may conclude the fair market value of the Total Unit of Company Alpha, as of January 1, 2021. However, the signed appraisal report may not be prepared by the analyst and sent to the appraisal client until April 30, 2022. In this scenario, the appraisal date is January 1, 2021, and the report-issue date is April 30, 2022.

In the above example, counsel should understand that the value opinion is based on information that was known and knowable as of January 1, 2021. In other words, an appraisal report generally does not consider information that became available, or known, after the appraisal date.

Data and Information Sources

The appraisal report typically should include a section that documents the data and information that the analyst relied on to develop the appraisal analysis and conclude the value opinion.

When reading this section of the appraisal report, counsel should gain an understanding of both (1) the publicly available data and information and (2) the non-publicly-available data and information that the analyst considered (and relied on) in the appraisal analysis.

The source list of data and information considered by the analyst should include any financial-related documents (e.g., financial statements, property operating reports, empirical market data) and any non-financial-related documents (e.g., buyer and/or supplier contracts, leases, licenses) used in the appraisal analysis.

The source list of data and information considered by the analyst should allow the appraisal report reader to identify the documents needed to replicate the appraisal analysis.

Total Unit and Subject Property Description

The appraisal report should adequately describe for the reader the fundamental position of the Total Unit and the Subject Property. The description of the Total Unit and the Subject Property generally includes the following:

• A discussion of the history of the Total Unit and the Subject Property and their current positions
• A description of the purpose of the Total Unit and the Subject Property and the part they play in the taxpayer company’s operations
• A description of the markets that the taxpayer company serves
• A description of the competition (if any) that the taxpayer company faces and how it is positioned within that competitive environment 
• A discussion of the facilities and properties that comprise the Total Unit and the Subject Property
• A discussion of the taxpayer company’s significant relationships with related parties, clients, suppliers, and so on
• A discussion of any pending litigation or regulatory issues that are significant to the taxpayer company, the Total Unit, or the Subject Property
• A review of recent transactions (if any) of the Subject Property, Total Unit, or parts thereof
• A functional analysis of the Total Unit and the Subject Property that assesses the (1) assets/property employed, (2) functions performed, and (3) risks assumed by the operation thereof

Economic Conditions and Industry Conditions

The appraisal report should include an overview of the general economic conditions (including regional economic conditions, if applicable) and industry-specific factors that may affect the appraisal of the Total Unit and the Subject Property.

The economic conditions discussion may include a description of (1) economic growth, (2) inflation, (3) consumer spending, (4) consumer confidence, (5) effective interest rates, and (6) business spending.  In each unit principle appraisal assignment, the analysis of economic conditions should be tailored to the economic factors that most directly affect the Total Unit and the Subject Property. That is, each economic conditions section of an appraisal report will likely be unique and include a discussion of economic indicators that may help the reader understand potential future performance of the Total Unit and the Subject Property.

The industry conditions report section typically discusses:

1. how the taxpayer company’s industry operates and
2. recent trends affecting companies within the industry segment.

This report section may also describe:

1. the taxpayer company’s position in its industry segment and
2. the taxpayer company’s market share relative to other competing companies.

Taxpayer Company and Total Unit Financial and Operating Performance

As part of the UPP appraisal process, the analyst may consider the financial performance and financial condition of the (1) taxpayer company and (2) Total Unit, depending on the purpose and objective of the appraisal assignment. A summary of this financial analysis typically appears in the appraisal report.

The taxpayer company’s historical and current financial condition and financial performance is reflected on the company’s balance sheets, income statements, and cash flow statements. The appraisal report may include a discussion of the following:

• The changes in revenue
• The changes in profit measures (i.e., gross profit, operating income, pretax income, and net income)
• The changes in profit margins
• The changes in cash flow
• The payments of dividends/distributions
• The liquidity and working capital position
• The asset utilization by means of various financial or operational ratios 
• The cost basis of the Subject Property 
• The capital structure and leverage, and more

The appraisal report may also describe how the taxpayer company performs relative to other companies in the same industry segment. This comparative financial analysis may compare the financial strengths and weaknesses of the company and other guideline (or comparable) companies.

Further, the analyst may perform an analysis of the financial performance of the Total Unit. For example, in the case of an electric generation power plant, the analyst may consider data presented in the power plant operating reports.

Plant operating reports may include data regarding: 

• heat rate (a measure of operating efficiency, if applicable), 
• net generation (a measure of energy production), 
• capacity factor (a measure of utilization), 
• fixed and operating costs (may indicate levels of functional obsolescence), 
• profitability and returns on investment (may indicate levels of economic obsolescence), and 
• many other items. 

Moreover, the Total Unit performance may be analyzed by comparing its financial and operating performance to guideline (or comparable) property. Using our electric generation power plant example, the analyst may compare the subject power plant heat rate, to heat rates of similar power plants to identify potential existence of functional obsolescence. And, the analyst may compare the subject power plant capacity factor to capacity factors of similar power plants to identify potential existence of economic obsolescence.

The comparative financial and operational analysis should help the report reader to comprehend how the taxpayer company and the Total Unit performs relative to other companies and total units in the industry segment.

Financial Performance Normalization Adjustments

When necessary, the analyst may perform normalization adjustments (1) to the taxpayer company’s financial statements and (2) to selected guideline (or comparable) companies’ financial statements.

The normalization adjustments may be required to present the financial performance of the taxpayer company (and the Total Unit) on the same basis as the financial performance of the selected guideline companies (and, thus, the guideline total units).

The following are some of the normalization adjustments that the analyst could consider:

• extraordinary income and expense items
• nonrecurring income and expense items
• differences in inventory (and other) accounting methods
• nonoperating income and expense items
• non-arm’s-length transactions/arrangements
• the existence of customer and/or supplier contracts (e.g., power purchase agreements in the electric generation industry)
• the existence of government/regulatory benefits (e.g., production tax credits in the electric generation industry)

The appraisal report should clearly describe any normalization adjustments made and explain the reasoning for each normalization adjustment.

Conclusion

This article is the third in a four-part series describing considerations that legal counsel may make when choosing an appraisal analyst in a UPP appraisal context. This part of the series focused on the review of the UPP appraisal report.

Connor J. Thurman is a Manager with Vallit Advisors, LLC. Connor has over 6 years of experience in business valuation, tangible and intangible asset appraisal, and various other litigation services. He has written numerous articles in professional and peer-reviewed journals covering a variety of topics in his areas of expertise and has presented on these topics via webinars and conferences. He is an Accredited Senior Appraiser (ASA) with the American Society of Appraisers and is Accredited in Business Valuation (ABV) with the American Institute of Certified Public Accountants.

Connor can be reached at 443-482-9500 Ext 114 or cthurman@vallitadvisors.com

The preceding article was prepared by its author. The opinions expressed in the article represent the author’s and may not reflect the view and/or opinion of Vallit Advisors and its staff. Views/opinions are based on the specific facts and circumstances of each Matter.