From a small northwestern observatory…

Finance and economics generally focused on real estate

Litigation Miscellanea

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While much of my writing is on real estate investing, we’re probably better known at Greenfield for our work in complex property-related litigation. Naturally, we keep track key issues in the field as they affect finance, economics, and valuation. Here are a few choice pieces that recently crossed my desk.

Leasehold, Leased Fee, or Fee Simple?

More often than not, the valuation goal in litigation is the determination of market value, but market value of what? The often misunderstood link is the interest being valued. Fee simple is the most common (it is the complete bundle of rights — what you normally think of when buying real estate). Leasehold is the interest held by a tenant, and may have positive value if the lease rate is below market. Leased fee is the bundle of rights retained by the landlord, and it, too, may have positive value. These questions are at the heart of many commercial tax appeals, and the valuation questions are still very much up in the air.

Cox v. Grady Hotel Investments (Missouri Court of Appeals. Western District, July 28, 2020, 605 S.W.3d 575) addressed this very question. Grady purchased hotel improvements located on land leased from the Kansas City International Airport. Note that the land is exempt from property taxation. The County assessed Grady’s leasehold interest in the property at $13,447,000, but the state tax commission hearing officer demurred, holding that Grady had a possessory interest and as such the appropriate value was the purchase price less any costs toward new construction, or $7.3 million.

The full commission set THAT aside, and concluded that Grady did indeed have a leasehold interest, but the airport still owned the fee simple interest in both the land and the improvements. Thus, the commission held that the proper valuation should use the “bonus” method, which is the difference between the economic rent and the contract rent. Based on that, the Commission assigned a bonus value of zero. The Assessor appealed, and the Circuit Court held that the zero value was arbitrary and not supported by law, and thus the bonus value was not applicable. The Court ordered the commission to consider the sales price as evidence of value. Grady then appealed. The Court of Appeals concluded that the that the language of Grady’s original quit-claim deed was unambiguous, that Grady had purchased the “leasehold improvements” and that the title to the land and the title to the improvements were to be treated as separate items and that the bonus method was inappropriate.

Do the birds like it?

In 2002, Pollard Land Company purchased over 2000 undeveloped acres along the Savannah River north of Augusta, Georgia. It conveyed 463 acres to the Champions Retreat Golf Founders LLC which built a 27-hole golf club open only to members. Champions also sold 66 homesites on 95 acres and left 57 acres along the river undeveloped. The property is home to several rare species of birds, to the southern fox squirrel, and to several rare plant species. In 2009, Champions contributed a conservation easement to the North American Land trust covering 348 acres, including the golf course and the 57 acres (but not the course buildings and homesites). Notably, while the general public cannot access the land directly, they can view the land from the river, and across the river there is a large national forest.

The IRS and the Tax Court disallowed the conservation easement deduction, and Champions appealed. The IRS’s valuation expert agreed that many birds do use the property but opined that the habitat itself was not “relatively natural” due to the fairways and greens, which contained non-native grasses. The IRS also argued that the land was not open to the general public. However, in Champions Retreat Golf Founders LLC v. Commissioner of the IRS (11th Circuit Ct of Appeals, May 13, 2020, 959 F3d 1033) the appeals court found that Champions was entitled to the deduction, noting that members of the public could canoe and kayak thru the easement, and birds do live on the property and “apparently find the habitat quite suitable.”

Is the easement in perpetutity?

Hoffman Properties of Cleveland, Ohio, donated a historic façade easement to the American Association of Historic Preservation, and took a tax deduction of $15 million. One requirement for such a deduction is that the easement must be in perpetuity. However, Hoffman and the Association included a caveat in the donation that Hoffman could alter, reconstruct, or change the appearance of the façade upon approval of the Association. Further, if the Association failed to give or deny approval within 45 days, then approval was deemed to have been granted.

The Court held that this caveat constituted a lack of perpetuity to the easement. Further, the Appeals Court held that the 45-day clause went even further, divesting the Association of the power to enforce protections if it failed to act within a narrow window. Thus, the deduction was disallowed in Hoffman Properties II LP v Commissioner of Internal Revenue (6th Circuit Ct of Appeals, April 14, 2020, 956 F3d 832).

Is a rezoning likely?

In Helmick Family Farms LLC v. Commissioner of Highways (Sup Ct of Virginia, August 29, 2019, 297 Va. 777) the key issue in valuation for a highway department condemnation was whether or not the rezoning of the ag land to commercial. The Commission valued the land, which zoned agricultural and used for cattle grazing and growing hay, at $20,281. However, Helmick offered expert testimony and valuation that the county had planned for several years to redesignate this for commercial or industrial use, and that the market value was thus actually $321,000. At the trial court level, the Commission successfully moved to have Helmick’s expert testimony excluded, holding that it was speculative. On appeal, the Supreme Court noted that Virginia law had never directly addressed this, but that there was a “avalanche of authority” from other jurisdictions that such testimony was generally permitted. The key element was that this rezoning was likely, and therefore a willing buyer, with reasonable knowledge of this, would factor it into the purchase price and thus this testimony should be admissible.

Thanks to Benjamin A. Blair, JD, of Faegre Baker Daniels LLP, writing in various recent issues of The Appraisal Journal for bringing these to my attention. As always, if we can elaborate on any of this, or answer any of your questions about these or other complex property cases, please let us know.

John A. Kilpatrick, Ph.D., MAI, john@greenfieldadvisors.com.

Written by johnkilpatrick

March 19, 2021 at 12:45 pm

Posted in Uncategorized

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