Save money on property tax by properly valuing assets

Many organizations view property tax as a nuisance and relegate most aspects of compliance to the bottom of the priorities list or to the newest tax employee. That’s a mistake. Improper treatment of property tax considerations can result in a wrong assessment and literally cost you money.

More than you think

Property tax is the highest generator of business tax paid, according to a 2014 study by the Council on State Taxation. At 36.1% of the total, it is followed not even closely by sales tax, at 20.8%.

That makes a good argument for getting it right. Another reason? Whenever the economy slows down, assessors have found ways to prop up the tax rolls through additional property tax assessments. Leasehold improvements, regularly assessed in but a few states, are an example of items being newly assessed. It’s important to know the property tax laws of each state where you have locations and to keep abreast of legislation that might change them. You want to be fully prepared when a manager wants to know why an assessment has increased.

Obsolescence can be a significant factor when determining an asset’s value.

Functional obsolescence

Depreciation can take the form of functional obsolescence, an example being a computer system you bought a few years ago that is already obsolete. That kind of obsolescence is prevalent in manufacturing, where machines can become outdated quickly.

Functional obsolescence may occur for one or two reasons: excess capital and/or excess operating cost.

Excess capital is generated when the replacement cost is much less than the original cost. For example, LED televisions were originally about $10,000; now you can buy a new one for $1,500.

Excess operating cost results when something becomes too expensive to run. Maybe a piece of equipment has become inefficient, and new models run faster and more effectively. An example would be a newer printing press.  

Economic obsolescence

Economic obsolescence is a form of depreciation where loss of value or usefulness is caused by external factors, such as a weakness in the industry, reduced demand or increased competition. You can demonstrate economic obsolescence by showing actual capacity versus peak capacity. 

An example would be a paper mill, which once ran 24/7 and bought equipment to accommodate that. Now it runs half the time, and the work done by all that machinery can be done by touching a screen.

You can measure both forms of obsolescence using the cost approach to determine FMV:
•  Take the reproduction cost new ― the cost to make a duplicate at today’s prices ― less the physical deterioration, the functional obsolescence and the economic obsolescence.
•  Take the replacement cost new ― the cost to replace at the current time ― less the physical deterioration, the functional obsolescence and the economic obsolescence.

Don’t overlook obsolescence when you calculate value.
The basics

Simply put, personal property is property owned by an individual or business that is not affixed to or associated with the land; everything except real property. Personal property for a business would include machinery and equipment, computer equipment, office furniture and equipment, vehicles purchased and used by a business ― basically everything that isn't nailed down. In some states merchandise inventory, raw materials and work in progress also are assessed as personal property.

When you are getting ready to file a personal-property return, make sure assets are properly classified based on the particular jurisdiction. Classifications need to be correct because they can make a large difference in the depreciation tables assessors use ― a laptop versus a large piece of equipment, for example. And depreciation values are important, as discussed later.

Be smart, focused and concise when you review and assess assets, and know their value when you file. If you’ve determined a retail location has a $100,000 taxable assessment, be sure that’s the figure you get back from the assessor. A simple clerical error can create an incorrect assessment, and if you are not timely in your review, you may have to pay on a number that is not accurate.

Likewise, if you are in a state that taxes inventory, and you’ve increased your inventory, know what the legitimate value is. If you appeal an assessment that turns out not to be inflated, you can lose credibility fast.

Fixed asset reviews
Most important to valuing property for tax purposes is the fair market value (FMV) in exchange, or what a willing buyer and seller agree an asset is worth. There are many factors to consider when determining FMV.

Depreciation is a big factor. In the Grant Thornton LLP webcast Property tax developments and trends, 65.8% of respondents said that depreciated assets are a major concern regarding personal property taxes. Determining an accurate depreciable life could reduce the tax life of an item and result in accelerated depreciation and a lower tax bill. That is important in terms of correcting erroneous assessments based on the generalized tables used by local officials.

For example, say you bought an asset for $1 million five years ago. An assessor said the asset had a 10-year life. Yet after only five years it is worth $100,000, its residual value, or the value at the end of its useful life. If the asset has hit its residual value after five years, not 10, that cuts the dollar value in half and could result in significant tax-dollar savings.

Ghost assets and why they’re important

Money can be saved by identifying and eliminating ghost assets, or fixed assets in a general ledger that cannot be accounted for because they are not on-site at the facility. This could include any number of items: an outdated computer system donated to a school district, a truck no longer in use, a set of printers that has been replaced several times. Once such assets have been depreciated, companies spend little time tracking them down and writing them off. And that’s where they can start adding to a personal property tax base and overstating the costs and the accumulated depreciation balances on your financials.

Thirty-eight states impose personal property tax on ghost assets ― only Nebraska relies on net book value. Everywhere else you’re paying on a residual value. If you have a ghost asset you bought for $1 million in 1950, and it has a 30% residual value (such as in Indiana), you’re paying tax based on a $300,000 value. That’s an issue you need to resolve.

To manage ghost assets effectively, you need to start at the beginning, by creating distinct identifiers for every newly purchased item and using a code tracked through software (or manually), so that your assets can be traced throughout their life cycle. You should conduct a physical inventory annually to account for all fixed assets.

Other factors to consider
  • Pollution controls. Many states give pollution control abatements a beneficial tax treatment. If you have a large plant, for example, pollution control mechanisms may be embedded in machinery and elsewhere. Don’t miss a chance to save money by failing to identify appropriate items as pollution control assets.
  • Intangibles. You can also save money by pulling out intangibles, such as intellectual property, R&D, copyrights, trademarks, patents and goodwill. You can receive a book of invoices 12 inches high, review the purchases and inevitably find items you can extract as intangibles.
  • Old money versus new. In the whirlwind age of multiple M&A, purchase price allocations have become commonplace, and the actual costs of assets can get lost in the shuffle. Significant tax savings can be achieved by distinguishing between the historical cost and the original cost, and filing returns based on the most beneficial allowable cost. For example, if 55 line items have one date, chances are the company was bought out. Go back to the plant controller and ask for the historical records. Using new costs today when valuing assets purchased 10 to 15 years ago can be advantageous, as people then were most likely paying at a premium.

Through fixed asset and invoice reviews, a savvy tax department can cut down the taxable costs and aim for the lowest tax base possible.

Don Lippert Jr.
T  +1 312 602 8042

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