Converting existing rental properties into for-sale condominium units can result in substantial profits. But if the developers behind such conversions are not aware of potential property tax pitfalls, a substantial portion of that anticipated profit may end up in government coffers.
Developers often underestimate the impact of property taxes during the conversion process. They fail to realize that the watchful eye of the government tends to focus on what are seen as potentially lucrative developments, often resulting in aggressive assessments before a conversion is even complete.
In many instances, developers underestimate the length of time needed to complete a conversion. They believe that by the time the assessor recognizes the conversion and reflects it in the assessment of the property’s value, they will have sold all the units and the property tax increase will be the buyer’s problem. But delays in receiving construction materials, weather, a softer-than-anticipated market, and other problems often slow down the conversion process. If any of these problems occur, the developer is likely to be stuck with excessive assessments on some, or even all, of the units for the first year or two during conversion.
Finally, developers sometimes overlook the challenge that assessors face in attempting to accurately assess a property while it is in transition from essentially one property type to another. For any or all of these reasons, the conversion of rental units to condominiums often results in erratic assessments.
If condominiums are overvalued by an assessor, the mistake usually falls into one of three categories: valuation, classification or timing.
All too often, assessors simply value condominiums that have been, or are being, renovated at the price at which they are, or will be, listed for sale. Of course, this simplistic approach may be accurate if (1) the renovation is complete as of the statutory assessment date, and (2) the market is strong enough so that the units will be sold at or close to the listing prices within a short period of time.
But some of the units may not sell for months, or even years. And the units that do sell may be sold at less than the listed prices. These situations, and therefore excessive property taxes, tend to occur in a softening market. If the assessor values a developer’s units at the listed sale prices, the developer should consider filing an appeal to contest the valuation. The basis for this appeal lies in the fact that the sales prices projected to occur over the coming months need to be discounted to reflect the present value of those units.
Assessment ratios differ from state to state, depending on the type of property being assessed. For example, in Tennessee multifamily rental property carries a classification of “commercial” and is assessed at 40% of fair market value. Condominiums held for sale are considered “residential” and assessed at 25% of fair market value. As of the assessment date following the conversion of the property from rental units to condominiums for sale, the property’s assessment ratio should be reduced from 40% to 25%. Developers need to familiarize themselves with the assessment laws in their own states and file property tax appeals in the event that their property is subjected to erroneous classifications.
Timing issues cause most of the problems that produce excessive property taxes on recent condo conversions. In some instances, the assessor’s high valuations may be more premature than wrong. For example, in a recent case in Tennessee, a developer purchased an apartment building with the intent to convert the units into condominiums for sale. The purchase occurred in the fall of 2004, just a few months before the Jan. 1, 2005, date of assessment in Tennessee. By the assessment date, the developer had complied with the legal requirements to change the property into condominium units and had spent approximately $300,000 in common-area improvements. The renovation of the units, however, had not begun. Nevertheless, the developer included in its marketing materials the post-renovation price list of the units.
The assessor obtained the price list and simply valued each unit at the developer’s asking price. The total value placed on the property by the assessor came to a significantly greater amount than the developer had spent on the project at that point.
The developer appealed the assessor’s action, contending that post-renovation anticipated sales prices should not be used in order to determine pre-renovation value. The assessor argued that once the property was legally converted to condominium units, the developer had already realized the appreciation that would ultimately be captured as sales took place. The Board of Equalization ruled for the developer, resulting in a significant tax reduction.
In the final analysis, let the developer beware: When a change in property use occurs and creates a real or perceived pot of gold, the taxing authorities are quick to exploit it. And that reality cuts across state lines and also cuts into a developer’s hard-earned profits.
Andy Raines is a partner in the Memphis, Tenn., law firm Evans & Petree. P.C., the Tennessee and Arkansas member of American Property Tax Counsel, a national affiliation of property tax attorneys. Andy Raines can be reached at