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LEASE AGREEMENT REFERENCE GUIDE 310: STRATEGIES FOR REAL ESTATE TAXES $24.95


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Lease Strategies
310

Product Overview

This LARG contains the following items:

Tales of TIF's and PILOTS: Would You Know a Tax If You Saw One?, Tenant Check List for Real Estate Taxes, and the Lease Clause Critique: The Pro-Landlord Real Estate Tax Clause.

Number of Single Spaced Pages: 12

 

Excerpt

Tales Of TIFs and PILOTS--Would You Know A Tax If You Saw One?

 

Consider a "hypothetical" situation. You are the president of a service company that occupies about 100,000 square feet as a tenant in a first class office building on the West Coast. You moved in almost a year ago. Your accounts payable person walks into your office with a copy of the tax statement just received from the landlord setting out your proportionate share of taxes for the year, but there are some very unusual items listed on the statement.

One line item is for a job training and placement program assessment for the city in which the building is located. Another line item is for master water and sewer trunk lines installed by a special assessment district set up by the landlord to serve only the building in which you lease space. Another line item is for a "recreational assessment district" that conducts fitness classes in the common areas outside the office building, and which installed a parcourse around the building for exercising executives and their staffs.

"There must be a mistake," you say. Your attorney says there's no mistake. "The tax clause in the lease gives the landlord the right to pass this stuff through to us as taxes and special assessments," he says. You decide you need three aspirin.

New Breed Of Assessment

This "hypothetical" situation is not so hypothetical. Many cities and counties have passed antidevelopment ordinances or propositions which can require developers to contribute to various community projects or facilities. Such contributions are in addition to an existing slate of heavy development fees. The other type of "special assessments" mentioned in the example are also becoming all too familiar in the development community.

In the old days, it used to be easy to spot a tax and a special assessment. Virtually all infrastructure necessary to accommodate development was built by the cities, the counties, or the state. Now, in an increasing effort to get development to pay for (and actually build) such improvements, special districts and public/private entities with taxing power have proliferated. And, as developers have been forced to play ball with such entities, they have sought to pass the cost from such entities through to the tenants in their buildings via the tax clause.

Many of such costs, especially when they don't even look like a tax or special assessment (i.e., when the entity imposing or administering the program or expense doesn't possess a statutory taxing power) are passed through to tenants as an "operating cost" under the lease. But when they look like a tax or special assessment, they often find their way into the real estate tax clause, subject to the precise definition of real estate taxes in the lease.

Facility Fees Spread

Tax hungry jurisdictions across the country have imposed a variety of facilities fees upon developers to finance infrastructure items required by development. This practice began in earnest after the enactment of Proposition 13 which restricted the amount real estate taxes could be increased in the state of California. Following Proposition 13, many cities and counties across the country have adopted special districts or special assessment districts which impose assessments to pay for parking structures, traffic improvements, street lights, mass transit subsidies, and subsidies for employment or social programs.

In many cases, payment of facilities fees is required in order for the developer to obtain building permits or other developmental approvals from regulatory agencies. While tenants traditionally have not objected to paying "special assessments" because they were infrequent and generally of nominal cost, the sophisticated tenant is well advised to examine the new breed of facility fees to see if they are misleadingly labeled as special assessments by developers seeking to pass through capital development costs to tenants as taxes under the lease.

Many tenants take the position that facilities fees imposed to pay for traffic improvements (or other infrastructure items) or required to obtain necessary permits are a cost of development, and must be paid for by the developer through minimum rentals derived from the project.

Many municipalities are redeveloping portions of their communities through redevelopment agencies. These agencies can and do impose special assessments upon developers to pay for redevelopment costs. Are these assessments properly reimbursable by tenants as "special assessments" or are they really a capital cost that should be paid by the developers as a project cost ultimately to be repaid through minimum rentals from the project?

Sophisticated Municipal Finance

One of the chief reasons that it is increasingly difficult to categorize payments as special assessments or taxes, is that the cities and counties (and in some cases, the federal government) have become more innovative in their taxing and finance methods. Many jurisdictions have utilized Tax Increment Financing (TIF) to finance infrastructure and development related improvements. Still others have used Payments In Lieu Of Taxes (PILOTS) to get revenue where traditional taxation mechanics proved unworkable or too inflexible.

Getting Down To The Definition

What this all means is that the definition of real estate taxes contained in the lease (and its specific ingredients) is more important than ever for both the landlord and the tenant. If unusual items like PILOTS or special assessments that benefit only the landlord's property are intended to be paid for by the tenant on a proportionate share basis, they had better be properly and specifically included in the tax clause and defined as taxes. (See, for example, the Lease Clause Critique in this LARG which considers the Pro-Landlord Real Estate Tax Clause.)

What Makes It A Tax These Days?

Certainly, the tenant should have little to complain about when traditional taxes and assessments levied by long standing taxing authorities (e.g., counties) are included within the definition of real estate taxes in the lease. When unusual items are included in the definition, it behooves the tenant to know as much about such items as possible, in advance of actual lease negotiations. Obviously, the way to do this is to obtain copies of the official documents (e.g., statutes, resolutions, etc.) establishing the taxing entity, minutes of its meetings, if applicable, and other official information concerning the mechanics and legal authority of the entity.

The tenant might also want to consider the following factors when deciding how much to object to the inclusion of the impositions of the particular entity:

  • How much is the annual imposition, and what is the tenant's pro rata share?
  • Are there legal restrictions on the amount impositions may increase in the future (e.g., are there caps on increased assessments)?
  • Is the entity dependent upon sources of revenue that might not materialize, making the likelihood of assessment increases one of high degree?
  • Are there several participants in the entity (i.e., are many properties and many owners participating, as opposed to just a few or one)?
  • Are there many parties that receive benefits from the entity (or just a few)?
  • Does the entity have clear legal authority to enforce assessments?
  • What is the history of the taxing entity, and how did it come into being?
  • How much control did the landlord exercise in the creation of the entity, and how much of the entity's benefit was he able to get for himself?
  • Are the improvements constructed or financed by the entity primarily on-site or off-site in relation to the development?
  • Are the improvements constructed by the entity of a type normally or typically built by the landlord, and paid for by project construction funds?
  • How much does the taxing entity look and act like traditional taxing authorities in what it builds and how it raises its revenue?

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