My property is worth what? How the county assessor values real estate for tax purposes.

Mar 18, 2020 | Real Estate Law

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Before the 1st Monday of June, each county assessor will send out the 2020 assessment notices. Those notices state the market value of each parcel of real property in the county. 

The law is well-established in Idaho regarding assessments of real property for tax purposes. Generally, all real property subject to property taxation must be assessed annually at market value for assessment purposes as of 12:01 a.m. on January 1. (I.C. § 63-205(1).) Market value is to be determined according to the requirements of Title 63, Idaho Code, and the rules promulgated by the State Tax Commission.

“Market value” means the amount of United States dollars or equivalent for which, in all probability, a property would exchange hands between a willing seller, under no compulsion to sell, and an informed, capable buyer, with a reasonable time allowed to consummate the sale, substantiated by a reasonable down or full cash payment.” (I.C. § 63-201(15).)

Rule 217 of the Property Tax Administrative Rules adopted by the Idaho State Tax Commission provides that when assessing real property, the assessor shall consider the sales comparison approach, the cost approach, and the income approach. (IDAPA 35.01.03.217.02.) Rule 217 also provides that “‘Market Value’ for assessment purposes shall be determined through procedures, methods, and techniques recommended by nationally recognized appraisal and valuation associations, institutes, and societies and according to guidelines and publications approved by the State Tax Commission.” (IDAPA 35.01.03.217.03.) Additionally, Idaho Code section 63-208(1) requires “that the actual and functional use shall be a major consideration when determining market value for assessment purposes.”

The market value of property often varies depending on the approach used by the assessor. The different approaches are:

  1. Cost Approach. The cost approach relies on the principle that no one will pay more for a property than it costs to replace it. Take a commercial building. The real estate is valued using the comparable sale method. What does it cost to purchase a similar piece of real estate? The assessor will make adjustments for location and other features that bring the market value of the property up or down related to the subject property. The building is determined by a valuation of how much it costs to build the replacement brand new less depreciation.
  2. Sales Approach. The sales approach looks at sales that happen in the vicinity and compares those to the subject property. The assessor then determines the value of the property based on what other similar properties are selling for. The more sales, the more accurate the data. The fewer sales, the less accurate the data.
  3. Income Approach. The income approach asks what a particular property will generate in net income (i.e., lease payments or other revenue minus expenses). The profit that an investor expects to make from the property on an annual basis is used to determine the value. There are two ways to value property under the income approach.
    • The first is the direct capitalization method. It takes the net income for a year and divides it by a rate of return to come up with a value. For example, if a property generates $100,000.00 in net profit and the investor is demanding a 10 percent return on her money, the value of the property is $1,000,000.00 ($100,000.00 divided by .1 equals $1,000,000.00). This method is simple to employ and understand.
    • The second approach is the discounted cash flow (DCF) method. It is much more complicated. With the DCF, the value of the property is based on its future cash flows. DCF analysis attempts to figure out the value of a property today, based on projections of how much money it will generate in the future. It is complicated and any error or wrong assumption can change the value a great deal.

Knowing how the assessor determines the market value of properties is important. Most assessors apply the cost approach. Why? It’s simple. All you need to do is determine what the cost of a building will cost to build brand new and then apply an arbitrary depreciation number to reach the fair market value of the building. The value of the land is determined by the sales comparison approach. As long as there’s adequate sales, this methodology for determining the value of the land is somewhat defensible.  

The problem with the cost approach is it is rarely used in the marketplace. Few investors ever use the cost approach when determining whether or not to buy a property.

It is much more common for investors to use the income approach. They look at the asset, determine the net profit it will yield per year and determine what they’re willing to pay for it. Some investors use the direct capitalization method, some investors use the discount cash flow method. That said, almost all investors look at the profit and loss of the property or a projected profit and loss of the property to determine what they are willing to pay.

The sales approach is also more accurate than the cost approach, but it’s still subject to attack. An assessor will often make subject adjustments to comparable sales based on location and other factors. These adjustments greatly affect the ultimate value of the property. Moreover, few investors care what another investor paid for a property other than to see if the capitalization rate (rate of return) they use is reasonable. Investors are more sophisticated than simply looking at the market place and seeing what other properties sold for. They really look at the specific property, its location, and its ability to generate a return. Though the assessor often will come in with stacks and stacks of comparable sales, they may have not connected to market value. Especially in income-producing properties, the market value is really determined by the return to the investor on that property.

When property owners find out the assessed value of their property, understanding how the assessor approaches the valuation of each property is important. This is especially true if the property owner wants to appeal the valuation to try to lower the property taxes. Keep in mind, all appeals are due on or before June 22, 2020. (I.C. § 63-501A.)