Daily Development for Friday, November 7, 2008
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Husch Blackwell Sanders
Kansas City, Missouri

Another contribution from Ira Meislik, our New Jersey reporter.

STATE AND LOCAL TAXATION; PROPERTY TAX; VALUATION: Taxpayer, owner of a catering facility, loses both on the issue of “entrepreneurial profit” and on the issue of deducting for “functional obsolescence” due to lack of parking. 

Westwood Lanes, Inc. v. Garwood Borough, 2008 WL 3854462 (Tax Ct. 2008)

A catering facility challenged its tax assessment.  The catering facility and the municipality each retained experts to calculate the property's value.  Both experts relied on a "cost approach" to value. The catering facility's expert did not include "entrepreneurial profit" as a factor in measuring the property's value, whereas the municipality's did. 

Entrepreneurial profit is a measurement of the profit a property owner would receive for its renovations to the property in anticipation of a resale and the associated risk.  The catering facility's expert claimed that there was no entrepreneurial profit to be inferred for the property since it was custom-built as a catering hall and catering facilities are not constructed with the expectation of resale profit. 

The opinion is useful to researchers and to others dealing with the question of “entrepreneurial profit” both because of the court’s thorough discussion of the issue and also because of its ten page chart analyzing other cases in New Jersey discussing the issue.

In the end, the Tax Court rejected the catering facility's argument, finding that the catering facility's location in an expanding commercial district gives rise to an inference of entrepreneurial profit.  It concluded that anyone buying the property would take into account the possible value that might be obtained by remodeling and reselling, and would not rely exclusively on potential revenues from catering operations as a basis for computing value.  Therefore, the Tax Court found it reasonable to conclude that renovations made to the property were made in anticipation of realizing a profit when the property was resold.  Since the catering facility did not calculate entrepreneurial profit, the Tax Court relied on the municipality's calculation instead. 

The Tax Court then reviewed the competing calculations for functional obsolescence.  Functional obsolescence is a measure of calculating the diminution in value of a property that is caused by a flaw in the structure, materials or design of the property, when compared with its best use and most cost-effective design.  Functional obsolescence may be curable or incurable.  In this instance, the owner argued catering facility was functionally obsolete because it lacked sufficient parking, leading to “economic obsolescence.”  However, insufficient parking may be cured by either leasing or purchasing a neighboring property, as the catering facility did when it leased the neighboring property.  When valuing the diminution in a property's value due to functional obsolescence, one can calculate it using either a replacement cost method or a reproduction cost method. In this case, however, the catering facility calculated the diminution in value by deducting the cost of purchasing the neig
hboring property. 

The Tax Court found that the catering facility's calculation made no sense because it resulted more than a thirty-three percent diminution in value.  It refused to accept the proposition that the property, if used as a catering hall, would be worth about $1,800,000 less than its worth for a different purpose.  In addition, the Tax Court found illogical that, prior to acquisition of an adjoining property for a parking lot, the catering facility property would be worth about $3,000,000, but that after buying the adjoining property, its property would be worth about $4,800,000, while, in addition the catering facility would then own the adjoining property valued at about $1,650,000.  If this were true, then clearly the “highest and best use” of the property would not be as a catering hall - an assumption that underlay the landowner’s appraiser’s earlier computations on other elements of the appraisal.

Comment: Although anything with numeric calculations, which appear throughout this opinion, is beyond the editor’s pay grade, the editor found the two issues discussed above sufficiently engaging to study the opinion for a little additional education.  Although the landowner got creamed in this case, study of the concepts and techniques may assist in dealing with appraisal evidence in a variety of other concepts, not the least of which, of course, is a tax appraisal. 

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