Many regional mall owners are surprised when they receive tax notices indicating that their property tax assessments are higher than their development or acquisition cost.  The reasons for this phenomenon are often simple to explain but difficult to reverse once the value is on the rolls.  This article will explore a typical scenario and offer some tax planning strategies to prevent its occurrence.

A regional mall in the Southeast U.S. was developed in 1997.  Like many new malls, it is situated on 100 acres and encompasses more than 1 million square feet of gross leasable area.  It is anchored by four popular department stores, which own their own land and buildings, and are therefore not part of the mall assessment.  The mall developer's land and in-line stores cost $160 per square foot of leasable area to develop, but the developer's books also reflect the costs of the anchors' land, site work and other inducements.  Further, because the developer made a strategic decision to expedite the lease-up of the in-line stores by financing tenant start-up costs, the balance sheet reflects significant above-standard tenant improvement allowances in exchange for higher rents.  Total project costs (land, mall construction, anchor inducements and tenant improvement allowances) reported in its SEC filings reflect a project cost of $220 per square foot.  The developer, concerned that its assessment will come in higher than $160 per square foot, is shocked to learn that the mall was assessed at $300 per square foot.  How did this happen?

The assessor viewed the new mall as two distinct types of properties;  the mall shops and the anchor department stores.  The assessor estimated the net rents generated by the mall shops at $24 per square foot and the department stores at $4 per square foot.  Capitalizing the mall rents at 8 percent produced a $300 per square foot value for the mall.

On the other hand, the department stores were valued at $45 per square foot, less than half the cost of construction.  Not surprisingly, the department stores did not appeal their tax assessments.  In its appeal, the developer produced project cost information showing mall costs of $160 per square foot, anchor inducements of $40 per square foot and above-standard tenant improvement allowances of $20 per square foot.  The local board, however, concluded that all costs $220 per square foot) should be included in the assessment plus an entrepreneurial profit of 15 percent.  The board's decision reduced the assessment from $300 per square foot to $250 per square foot.

Was this a fair outcome?  How could a better outcome have been achieved?  In most cases, once a proposed value is put on the assessment roll, the best one can hope for is to whittle it down.  In the above-described scenario, the taxpayer was able to achieve a 16 percent reduction from the proposed value.

Should the assessment have been reduced further?  Absolutely!  Why wasn't it?  Because, in most states, assessors are presumed as a matter of law, to be correct.  And, as a practical matter, even if a board believes an assessor is wrong, it usually assumes that he can't be off by more than 20percent.  Proving that an assessor erred by 50 percent is almost impossible psychologically.  This kind of outcome cannot be reversed, but it can be prevented.

That's where tax planning strategies come into play.  In the case of a regional mall, a two-pronged strategy is recommended.  First, project costs need to be segregated among those related to the in-line stores (the proper basis for assessment), those related to off-site expenditures such as anchor land and inducements (some of which may be assessed to the anchor tax parcels) and those related to financing tenant start-up costs (non-assessable costs attributable to tenant fixturing, equipment and inventory).  To the extent these costs reflect different operating segments of a mall development, entity structuring by segment may be appropriate.

The second step is to account for the operating revenues and expenses attributable to the investment in anchor inducements and the financing of tenant improvement allowances.

A return on investment attributable to the anchor inducements should be measured and reported.  This can be done in any number of ways, for example, by means of an imputed rate of return on investment or by amortizing the investment based on the cost of capital.  Similarly, a return "on and of" the investment in above standard tenant improvement allowances should be computed and reported separately from the rental income of the property.  With out this type of segregation of costs, revenues and expenses, regional malls are subject to being assessed far in excess of the value of the underlying real property.

Kenneth J. Rogers is director of real estate analysis for Fisk Kart Katz and Regan, Ltd. in Chicago. krogers@proptax.com