Daily Development for Monday, June 18, 2001

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

TAXATION; PROPERTY TAX; PERSONAL PROPERTY: An owner/landlord remains liable for unpaid ad valorem taxes and tax delinquencies levied against improvements on taxpayer's land despite the fact that, during the relevant taxing period, improvements were constructed and owned by tenant, who was contractually required to pay the taxes, and received the only bills.

Franz v. Katy Ind. School Dist., 35 S.W.3d 749 (Tex. App 2000).

Appellant leased a parcel of land to a restaurant tenant in 1983. The tenant built a restaurant building on the site, and the lease provided that title to such improvements would remain in tenant until the expiration of the lease term. The lease provided further that appellant would pay a stipulated amount of the ad valorem taxes on the property and that the tenant would pay the balance.

Appellant and the tenant applied to the appellee taxing authorities to separate the taxes on the land from those levied against the improvement and were granted separate tax bills. While appellant then paid its taxes levied against the land, the tenant never made a payment on the ad valorem taxes applicable to the improvements from 1988 to 1995, which amounted to nearly $200,000 with penalties and interest. Tax bills for the improvements taxes were sent only to the tenant.

In 1995, appellant filed an unlawful detainer action against the tenant and terminated the lease. The next year, appellant filed this case against all applicable taxing authorities (the school district, the city, the county, and the local hospital and flood control districts), seeking a declaratory judgment that the delinquent taxes on the improvements did not constitute a tax lien against his land, and that any tax lien that did exist would be extinguished with a demolition of the improvements. Both theories were rejected by the trial court, which held that, indeed, the taxes levied against the improvements on appellant's land created a tax lien on the land itself, not removable by demolition.

On appeal, appellant argued that since the Texas Tax Code allows for the separate taxation of land and improvements, that a lien on improvements cannot impose a lien on the underlying land. The Court of Appeals rejected this argument, finding that the Tax Code simply provides an administrative procedure for separate billing; but the underlying landowner's tax liability is remains unaffected by the separation of tax statements and even the separation of ownership.

The court went on to find that, in any event, the merger of the term interest in the improvements and the fee simple estate in the land via the termination of the lease created a tax liability for appellant in the full amount of the delinquent taxes owed on the improvements. The Court analogized the landlord's status on lease termination that of a purchaser of the property, who would also be liable for any delinquent real estate taxes.

The court reviewed principles of merger of real property interests were reviewed, and held that "the two estates (the improvements and the land) merged when [appellant] terminated the lease and assumed ownership of the improvements." As a matter of public policy, the legislative intent was not to provide a windfall to landlords or to reduce local tax revenues by separation of tax bills for ad valorem taxes on land and improvements.

Comment 1: Of course, the landlord could negotiated in the original contract a method for monitoring the tenant's tax payments, but apparently did not do so.

Comment 2: The editor assumes that, by parallel reasoning, a landlord's mortgagee would have similar difficulties were it to acquire the property in a foreclosure. . Mortgagees routinely require in their documents that mortgagor provide annual receipts for tax payments, but this is one of the several requirements "honored by neglect" in many mortgage relationships. Here, of course, the mortgagee would want to require not only paid receipts for the real property taxes from the mortgagor but also paid receipts from the tenant for the personal property taxes. So all mortgagees think of this? In Texas, at least, they'd better.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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