Low-income housing tax credit (LIHTC) properties continue to face uncertain treatment at the hands of property tax assessors who too often take a conventional approach to an unconventional appraisal assignment.

Most taxing jurisdictions require that real property be assessed at its market value using generally accepted appraisal techniques. Unfortunately, the unique characteristics of a LIHTC project make it difficult for assessors to apply standard market value definitions and approaches in making a fair assessment.

With an understanding of a few key concepts, however, a taxpayer can start a meaningful dialogue with their assessor about the best way to value a tax credit property.

Market value

The first step in the assessor's valuation process is to analyze the market value definition set forth by the state or local governmental authority. Most jurisdictions' market value definitions are a derivation of the following concept: Market value is the price for which a property would transfer in a cash sale between an educated buyer and a motivated seller, in an arm's-length transaction, after proper marketing wherein the parties had each acted knowledgeably, prudently, and without undue influence.

The problem with applying the typical market value definition to a tax credit property is that a LIHTC owner cannot sell, transfer, or exchange the property without meeting certain conditions and obtaining government approvals set forth in a land-use restriction agreement (LURA). These factors make for an extremely illiquid asset that seldom fits into the concept of a willing buyer and a willing seller in the open market.

Owners should argue that the assessor must consider the illiquidity of a LIHTC project when applying the market value definition. Therefore, they should ask for a 15 percent to 25 percent discount off an assessment to account for the illiquidity of the investment.

Appraisal methodology

Assessors will use generally accepted appraisal techniques when deriving a property tax assessment. The appraisal community defines these techniques as the three classic approaches to value: cost, sales comparison, and income.

In a LIHTC assessment, the assessor must carefully consider the applicability of each valuation approach, as well as the individual characteristics of the property. While most assessors will rely on the income approach, LIHTC owners should educate themselves on the inherent difficulties in using all three valuation methods when assessing a tax credit property.

Cost approach: Under the cost approach, an assessor will estimate market value by summing the cost to replace or reproduce the property with a new asset, and then depreciate that amount to arrive at current value of the improvement and land. The cost approach is an unreliable valuation methodology for LIHTC assessments, especially for older properties, because it is difficult to quantify the obsolescence brought about by the LURA restrictions.

In addition, a replacement or reproduction cost estimate does not reflect value associated with the future tax credits and does not account for the loss of income caused by the restrictions. In short, the cost approach is almost never a reliable valuation methodology for tax credit projects, and owners should aggressively protest valuations derived by assessors using this approach.

Sales comparison approach: A value derived using the sales comparison approach is based on what similar properties (otherwise known as “comparables”) in the market have recently sold for. Assessors make adjustments for time, size, and location to the comparables' sales prices when making the comparison with the owner's property.

As previously mentioned, LIHTC properties are extremely illiquid assets and rarely sell, especially during the first 10 years of the project. Partners sometimes sell their interest in the ownership entity, but those are not sales of the real estate.

If no LIHTC sales exist, owners can argue that the sales comparison approach should be rejected because the adjustments necessary to compare a conventional property sale with a tax credit property render the indicated value unreliable. If a LIHTC sale is found, the owner should make sure the assessor carefully considers the differences in that property and comparable properties' LURAs.

Income approach: With the income approach to value, an assessment is reached by capitalizing a net operating income stream into a value indication. Assessors will apply market-derived rents, expense ratios, and capitalization rates into a direct income pro forma to value the real estate.

The income approach is generally considered the best indicator of a LIHTC property's value, if it is applied correctly. When discussing an income-based assessment with an assessor, owners should address several key issues.

For one, rent ceilings set by the LURA may, or may not, be below normal market levels. The LURA's household income limits, too, may influence occupancy, administrative costs, and achievable rents.

Another factor often affecting LIHTC net income is management expenses. Tax credit properties require operational expertise and administrative duties that cause expenses to be higher than those for conventional projects.

Finally, the assessor must consider whether the benefits associated with the tax credits should be considered in the valuation analysis. A LIHTC's total value is derived from the real estate and the tax shelter benefits that come with the credits.

An argument can be made that the tax credits are not a benefit attributable to the real estate, but rather comprise intangible value. In most jurisdictions, assessors cannot include intangible values in their property tax assessments. Thus, arguing the intangible nature of the tax credits can often lead to reduced property values under the income approach.

LIHTC properties do not easily adhere to conventional market value defi- nitions and approaches to value. It is imperative that tax credit property owners educate their assessors about the uniqueness of their properties and start an ongoing dialogue with the assessors that will lead to lower assessments each tax year.

Gilbert Davila is a partner in the Austin, Texas, law firm Popp, Gray & Hutcheson. The firm devotes its practice to the representation of taxpayers in property tax disputes and is the Texas member of the American Property Tax Counsel, the national affiliation of property tax attorneys. Davila can be reached at [email protected].