What’s up with inflation? has been saved
Perspectives
What’s up with inflation?
How rising prices impact property taxes
The United States has recently been experiencing an increased rate of inflation. Consumers can readily see the impacts through higher prices at the checkout line. Businesses are also seeing increased costs for inputs of production. But how does inflation affect the value of fixed assets such as land, buildings, and machinery that are typically held over longer time periods? And how do those value changes figure into the taxation of those fixed assets?
Real estate valuations
Property tax assessments aim to capture a measure of fair market value at a given point in time. Due to the volume of property subject to assessment, however, assessing jurisdictions generally rely on mass appraisal techniques. Valuation indicators may include cost, income, and sales approaches. Commercial real estate is frequently valued using capitalized income measures, which consider the earnings ability of a property. In times of inflation and higher interest rates, the assumptions underlying the models may need to be revisited. If the rate of inflation exceeds the growth in operating incomes, models that assume relatively low inflation rates and interest rates may overstate the market value of income-producing properties. Taxpayers should endeavor to understand the variables in assessing jurisdictions’ capitalized income models. In contrast, residential real estate is typically valued using sales comparison approaches, which rely on recent market sales. Rising interest rates could depress selling prices, and assessed values based on recent sales data could fall. Nonetheless, based on property tax revenue requirements in some municipal finance laws, tax rates frequently increase when assessed values fall.
Personal property valuations
With personal property like machinery and equipment, rising prices could have a durable detrimental impact on property tax assessments. Most jurisdictions that tax personal property use the original cost of the property as a starting point and apply their own depreciation schedules to determine the market value of the property. If a taxpayer purchases a piece of equipment for $12,000 in an inflationary period that might be available in non-inflationary periods for $10,000, the equipment would be capitalized on the taxpayer’s books at $12,000. In the typical case, the cost reported on the rendition each year would be $12,000. The assessing jurisdiction would apply its depreciation schedule to the $12,000 reported book cost, and the inflation premium would be captured in the assessed value in every year the equipment is subject to assessment. If inflation recedes, and prices fall, taxpayers could use the principle of substitution to argue for exclusion of the inflation premium. Market value is in part a function of the principle of substitution. A buyer would not typically pay more for a piece of equipment than the price of a substitute of equal capability and function. A taxpayer would have a reasonable argument that looking forward, a subsequent buyer would not typically pay the inflation premium if equipment of similar function was available without the inflation premium.
For both real estate and personal property, taxpayers should be vigilant about monitoring their property tax assessments in periods of inflation and in depressed economic times. Mass appraisal techniques and models may not adapt quickly to changing economic conditions and generally will not capture valuation considerations that are unique to a given taxpayer. The onus is on the taxpayer to convey those unique valuation considerations to the assessing authorities.
Authored by: Debbie Loesel, Senior Manager, Deloitte Tax LLP
