A recent decision from the Commonwealth Court suggests that the Courts should look past intricate financing deals – and ordinary leasing arrangements – to get to the substance of real estate developments for their effects on tax revenue.
Tech One owns property near Century Three Mall in Allegheny County. In 1989 it leased the land to Terra Associates for development purposes. Tech One was to receive annual rent of $665,000. Terra Associates then began to develop the property with a shopping center, movie theater complex and a restaurant. After it was completed Allegheny County determined the development to have a value of $31,000,000. An appeal was filed by Tech One claiming that the only value to be placed on its retained ownership of the land came from its lease and that the value of the improvements were to be ignored because they were owned by someone other than the property owner. According to the terms of the lease, Tech One had no rights to the improvements at the termination of the lease.
Interestingly, the lease arrangement also provided that the lessee, Terra, was obliged to pay all taxes. It would of course be in Terra’s interest to have the lowest possible assessment. This could be easily accomplished if the value of the shopping center, theaters, and restaurant were ignored.
At the trial court level, Judge Wettick found in favor of the taxing bodies, and the Commonwealth Court recently upheld that ruling. In so doing Judge Wettick and the Commonwealth Court rejected the application of a line of cases deriving from the Pennsylvania Supreme Court’s 1992 Marple Springfield case from Delaware County. There too a lease provided for fairly low rent to the land owner, and the taxing bodies sought to determine value based upon the market rent to the land and the value of the constructed improvements. Marple Springfield held that the taxable value of land that is subject to a long-term leasing arrangement should be based strictly upon the lease rent to the land owner. Relying upon Marple Springfield, Tech One argued that it was the landowner and its interest (and therefore the assessed value) was to be based strictly upon the value of the lease.
What seems to be the difference? The major factor to the Commonwealth Court (and to Judge Wettick) is that uniformity of taxation is askew if there is no accounting for improvements made under the terms of the lease. If an owner/developer built the same commercial complex, it would be taxed for the full value of land and structures, while Tech One, would here escape taxation on the structures.
Of some significance, noted by the Courts, was the fact the lease here required the tenant to pay taxes, while in Marple Springfield the record was silent on that subject. Thus, we would have the owner of the buildings paying the tax on the underlying land which it does not own, and no one paying tax on the building value. There is an obvious absurdity in that effect.
Under the Marple Springfield approach, numerous financing arrangements are available today which would allow an owner to lease property to a legitimate holding/shell business and thus avoid taxation on improvements. Others might take to leasing the improvements to holding companies as a ground lease and in that way avoid the taxation of the improvements. The Court here looked beyond the troublesome holding of Marple Springfield to see this type of transaction as unfairly bypassing real estate tax obligations and placing the form of ownership over the need for uniformity of taxation. To paraphrase Judge Wettick, any other outcome would permit a Taj Mahal to be built, yet escape taxation. By affirming Judge Wettick’s decision, the Commonwealth Court recognized the various financing strategies that could be put in play, and seems to have sent a message that Courts should look to the realities and not the intricacies of financing and development schemes.
One solution to this whole problem would be to facilitate – by legislation or assessment practice – the direct assessment of improvements to land which are owned by an entity other than the owner of the underlying land. That would “capture” all of the taxable value just as if it were in single ownership, and would remove any tax incentive for separation of land and improvement by developers. Those decisions should be made on other economic bases, not simply as arrangements to avoid taxation for support of local school and government operations.
Given that this decision significantly departs from the Marple Springfield decision, the Pennsylvania Supreme Court may be asked to accept and hear an appeal. Look for more news if that occurs, and in the meantime do not hesitate to contact us with any questions.