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By Altus Group | April 3, 2017

The value of Real Estate Investment Trust (REIT) status for federal tax purposes tends to make REIT advisors skittish about property valuation for state and local tax appraisals. Many advisors would prefer not to appeal and risk overpaying property taxes, believing that a lower tax assessment could endanger values necessary to meet the Internal Revenue Service’s REIT’s quarterly asset and income tests.

However, it’s an unfounded fear, writes David Chitlik, Altus Group’s Vice President, Property Tax, Hospitality, in an article for the April 2017 edition of Hotel Executive Magazine.

IRS appraisers, enforcement professionals, and attorneys have all told David that values for REIT tests have nothing to do with those used in state and local property tax valuation. According to an IRS appraiser: “We never challenge or have REIT status overturned because of a lack of consistency with a state or local filing.”

The reason is given in Internal Revenue Bulletin 2016-39, which says, “local law definitions will not be controlling for purposes of determining the meaning of the term ‘real property’ as used in Section 856 (of the IRS code, which covers REIT establishment and rules) and the regulations thereunder.”

In essence, IRS rules are for the IRS, state and local tax rules for state and local tax jurisdictions. Like parallel lines, the rules for each don’t cross.

REIT advisors’ lack of understanding how the IRS applies rules governing asset and income tests can hold property tax valuations hostage. State and local jurisdictions happily accept tax overpayments.

David suggests a remedy: Create parallel accounting systems by valuing a property at purchase two different ways, one for REIT purposes, the other for state and local property taxes. He also offers an example of a $100 million hotel purchase in California, which operates under the notorious Proposition 13 to establish values for property tax purposes.

The values reflect different ratios of tangible/intangible assets, with an understanding that property taxes are paid on the tangible. Each of the two different sets of tangible and intangible values adds up to the sale price of the property.

Carry both ratios on the same set of books for both parties. The IRS doesn’t care about the property tax jurisdiction values, and while local and state assessors may ask to see the IRS valuation, they are not legally entitled to see the federal figures.

The remedy also suggests the value of two sets of advisors – one for the REIT, the other for consideration of state and local property taxes – when deciding whether to purchase a property. The two advisors reflect two different sets of expertise. Their common interest is saving REIT investors money.

Read the full article here. This is the fourth in David’s series on hospitality property tax issues published by Hotel Executive Magazine.

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