Economic, Functional and Physical Obsolescence: Effective Arguments - - PowerPoint PPT Presentation

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Economic, Functional and Physical Obsolescence: Effective Arguments for Business Personal Property Valuations

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1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Bob Weigel, Director, McGladrey LLP, S

• t. Louis

g , , y , S tephen Paul, Partner, Faegre Baker Daniels, Indianapolis Todd Barron, President, Barron Corporate Tax Solutions, Wheaton, Ill.

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E i F ti l d Ph i l Economic, Functional and Physical Obsolescence: Effective Arguments for B i P l P t V l ti Business Personal Property Valuations Seminar

May 17, 2012 Bob Weigel, McGladrey LLP bob.weigel@ mcgladrey.com S tephen Paul, Faegre Baker Daniels stephen.paul@ faegrebd.com Todd Barron, Barron Corporate Tax S

• lutions

tbarron@ barrontax.com

Today’s Program

Functional And Economic Obsolescence Claims From The Field [S t ephen Paul] S lide 7 – S lide 21 Quantifying Obsolescence, Evaluating Time Needed In Analysis [Bob Weigel] S lide 22 – S lide 34 Obsolescence Cases And Common Arguments From Assessors [Todd Barron] S lide 35 – S lide 78

FUNCTIONAL AND PHYSICAL

Stephen Paul, Faegre Baker Daniels

FUNCTIONAL AND PHYSICAL ECONOMIC OBSOLESCENCE CLAIMS FROM THE FIELD

Obsolescence

► In many states (such as Indiana), tax is assessed on business personal property

based on an adjusted cost that takes into account the ordinary diminishment of value j y

• ccurring because of age, technological advancements and physical wear.

► In some cases, however, a taxpayer might support additional reductions in value

because of extraordinary events or circumstances affecting the value of the property.

► In such cases, adjustments for functional and/or economic (abnormal) obsolescence

might be sought.

► Ahead are examples based on actual cases involving functional and economic

• bsolescence claims
• bsolescence claims.

8

Functional Obsolescence

► Adjustments that are made to costs to form the bases for assessments of business personal

property tax account for normal and ordinary wear and tear, technological obsolescence, and age of the property. Most jurisdictions base personal property tax on depreciated values.

► However, some conditions might suggest the presence of additional obsolescence - functional

• bsolescence - and symptoms of these conditions should not be missed:

Excess operating costs Excess construction or capital cost Over-capacity p y Lack of utility Inefficient or ineffective physical plant layout O id tifi d t th tif th b l ll t il

► Once identified, to then quantify the obsolescence usually entails:

Calculation of the present value of the cost-savings benefit that would accrue from resolving the problems causing obsolescence T k i t t th ti t d f l lif f th i t d bl di t Takes into account the estimated useful life of the equipment and reasonable discount rate based on the taxpayer’s weighted average cost of capital and/or industry data

9

Functional Obsolescence: Large Industrial Facility

► Large industrial facility case: Facts

Large Indiana industrial facility on the banks of Lake Michigan Large Indiana industrial facility on the banks of Lake Michigan Operating aged equipment Equipment purchased over period of many years, as plant outgrew its capacity ti many times over As new equipment was purchased, new real estate was developed on a landfill created after materials deposited into Lake Michigan. As a result, equipment operated in sequential manufacturing steps was installed miles apart. In order to keep certain steps in production near each other, duplicate items of machinery were purchased, with each of the duplicated items continuing to be used in production. The plant experienced some level of incompatibility among pieces of equipment p p p y g p q p purchased and installed many years apart.

10

Functional Obsolescence: Large Industrial Facility (Cont.)

► Large industrial facility case: Symptoms of obsolescence

Increased production costs because of inefficient and sub-optimal plant layout Increased production costs because of inefficient and sub-optimal plant layout Inefficiencies in production cycle times because of poor layout of plant Incompatible technologies increased production costs. Increased overhead costs resulting from aging of equipment and design and layout of plant

11

Functional Obsolescence: Large Industrial Facility (Cont.)

► Large industrial facility case: Quantification of functional obsolescence

Demonstrated a cost to cure the symptoms of functional obsolescence (cost to fix the Demonstrated a cost to cure the symptoms of functional obsolescence (cost to fix the plant so that excess operating costs no longer are incurred) Cost to cure inefficiencies in the plant design as to personal property was identified in larger fabrication of replacement plant (which was developed to capture value associated with functional obsolescence in the real property improvements).

► Large industrial facility case: Assessor’s arguments

Taxpayer’s claimed obsolescence was incorporated into normal obsolescence already p y p y reducing the value of the business personal property.

► Normal reductions to values accounted for technological advancements, physical

deterioration, incompatibility of older technologies with new, and inefficiency relative to newer equipment. However, assessor conceded that the way the plant was designed over time and its layout were inefficient and not nearly optimal.

12

Functional Obsolescence: Large Industrial Facility (Cont.)

► Large industrial facility: Resolution

Functional obsolescence on the basis of plant design and upon demonstration Functional obsolescence on the basis of plant design and upon demonstration

• f replacement plant was less complicated with real property.

Global settlement resolution was reached with the assessor, applying agreed- upon functional obsolescence percentage to all properties real and personal upon functional obsolescence percentage to all properties, real and personal.

13

Economic Obsolescence

► As explained in the functional obsolescence discussion, most jurisdictions base personal property tax on

adjusted cost values assigned to the property after taking into account normal and ordinary wear and tear, t h l i l b l d f th t technological obsolescence, and age of the property.

► Additional obsolescence – reductions in the income-generating capability of the property – caused by

external factors that are unexpected, unanticipated, and over which the taxpayer had no control constitutes economic (abnormal) obsolescence constitutes economic (abnormal) obsolescence.

► Claiming economic obsolescence requires:

Identification of the causes of obsolescence ; examples from Indiana regulation include acute government regulation and intervention (grounding planes after 9/11), natural catastrophes government regulation and intervention (grounding planes after 9/11), natural catastrophes Quantification of the loss in value of the affected property resulting from the obsolescence

► In Indiana, two methods of quantification are recommended by the state Department of Local Government

Finance: If impaired property is curable (future benefits>cost to cure), then obsolescence equals cost to cure (reduced by the same percentage applied to costs to arrive at taxable value before obsolescence). If un-curable (future benefits<cost to cure), then value reduced to documented net realizable value

14

Economic Obsolescence: Access To Facility

► Entertainment facility case: Facts

Entertainment facility on outskirts of large metropolitan area Entertainment facility on outskirts of large metropolitan area A bridge serving as only method within about 10 miles for ingress and egress to facility to/from the large city via interstate highway was shut down by the state Department of Transportation. Resulted in immediate reductions in admissions to the facility and declines in revenues Losses sustained over a period of years Taxpayer claimed economic obsolescence p y

► Entertainment facility case: Claimed cause of obsolescence

Bridge closure U ti i t d t d b d t ’ t l Unanticipated, unexpected, beyond taxpayer’s control

► Entertainment facility case: Symptoms of obsolescence

Substantially fewer patrons Material loss in earnings

15

Economic Obsolescence: Access To Facility (Cont.)

► Entertainment facility case: Quantification of obsolescence

Decline in earnings (period subsequent to bridge closing relative to period Decline in earnings (period subsequent to bridge closing relative to period preceding closing) was identified as the cost to cure (taxpayer could have selected the cost of repairing the bridge but rather opted for more conservative estimate using decrease in earnings). g g ) Determined that future economic benefits from use of equipment exceeds the cost to cure Obsolescence therefore calculated as the cost to cure (factored by the same Obsolescence, therefore, calculated as the cost to cure (factored by the same percentage applied to the historical cost of property to adjust to true tax value)

► Entertainment facility case: Assessor’s arguments

Obsolescence not calculated according to guidance from State Department of Local Government Finance

► Entertainment Facility Case: Resolution ► Entertainment Facility Case: Resolution

Case remains pending

16

Economic Obsolescence: Deterioration Of Market

► Two manufacturer cases: Facts

Manufacturers blamed deterioration of markets (both served automotive markets; one d h li k t) f d d l f i t served home appliances market) for reduced value of equipment. For both manufacturers, major customers had shut down plants and/or gone out of business. B th f t i d k k ti t i l t Both manufacturers incurred skyrocketing raw materials costs.

► Two manufacturer cases: Claimed causes of obsolescence

Both manufacturers blamed the poor economy and market conditions blemished by foreign competition, international trade policy, and manipulations of currencies by foreign governments causing competitive advantages for foreign competitors . Unanticipated, unexpected, beyond taxpayer’s control

► Two manufacturer cases: Symptoms of obsolescence

Reduced production volume (as much as 50%) Work force cut in half Work force cut in half Number of lines/shifts reduced substantially

17

Economic Obsolescence: Deterioration Of Market (Cont.)

► Two manufacturer cases: Quantification of obsolescence

In Case One, the taxpayer concluded that the obsolescence was curable and attempted to calculate it on the basis of an inutility penalty, reducing the value of the property based on the percentage shortfall experienced in production volume relative to capacity. In Case Two, the taxpayer concluded that the obsolescence was incurable and reported the net realizable (salvage) value of the property realizable (salvage) value of the property.

► Two manufacturer Cases: Assessor’s arguments

The assessor argued in each case that the taxpayer had not identified real causes of obsolescence. Causes identified were in common among all manufacturers operating in a weak economy. Causes identified were in common among all manufacturers operating in a weak economy. In Case One, assessor argued that a claim based on inutility penalty was an unacceptable method

• f calculating obsolescence (note that inutility may be used in other jurisdictions outside of Indiana).

► Two manufacturer cases: Resolution

Case One: Settled upon demonstration that identified causes had direct effect on taxpayer itself; calculation was rejected, but settled adjustment was agreed upon Case Two: Still in process; taxpayer is accumulating evidence of direct effect on it from poor t d l ti f i titi economy, trade regulations, foreign competition

18

Economic Obsolescence: Extraordinarily Aged

► Aircraft parts manufacturer: Facts

Aircraft parts manufacturer operated a plant where equipment generally had been fully depreciated

• n the taxpayer’s books, and the average age of the equipment was about 30 years .

Indiana law requires that personal property tax be calculated based on and adjusted cost of the property equal to at least 30% of historical cost. Market value of the equipment is much less than 30% of cost Market value of the equipment is much less than 30% of cost. Taxpayer claimed the difference between market value and 30% value as abnormal obsolescence.

► Aircraft parts manufacturer: Claimed causes of obsolescence

Taxpayer claimed that the difference between market value and the value equal to 30% of cost must be attributed to abnormal obsolescence. Normal obsolescence includes regular depreciation to account for technological advancements, physical wear, etc.. But, this adjustment was beyond normal obsolescence because of the age. p y , , j y g

► Aircraft parts manufacturer: Symptoms of obsolescence

Age of equipment Inflated value reported because of application of the “30% floor ” Inflated value reported because of application of the 30% floor.

19

Economic Obsolescence: Extraordinarily Aged (Cont.)

► Aircraft parts manufacturer: Quantification of obsolescence

Taxpayer submitted the difference between the true tax value reported on the Taxpayer submitted the difference between the true tax value reported on the personal property return - upon application of the “30% floor” - and the property’s market value, based on appraisal. Taxpayer claimed that the Department of Local Government Finance Taxpayer claimed that the Department of Local Government Finance recommends methods of quantification but it never precluded use of fair market value appraisals to compare to adjusted cost. Ai ft t f t A ’ t

► Aircraft parts manufacturer: Assessor’s arguments

Taxpayer did not identify causes of obsolescence. Taxpayer did not quantify obsolescence properly.

► Aircraft parts manufacturer: Resolution

Case is still pending.

20

Obsolescence: Concluding Thoughts

► Obsolescence above and beyond normal obsolescence already accounted for, in adjusting to

taxable values, should be claimed by taxpayers.

► Obsolescence cases can be difficult to prove – make the most out of most advantageous

negotiating position. For example, in the functional obsolescence example, the taxpayer benefited from combining its personal property argument with its strong real property position.

► Follow regulatory or other guidance provided by state or local authorities, in order to quantify

• bsolescence adjustments, whenever possible.

► General economic circumstances and market conditions generally are not enough to prove a ► General economic circumstances and market conditions generally are not enough to prove a

cause of abnormal obsolescence regarding a specific taxpayer’s property. Prepare to show how those conditions affect that property in particular. For example, the manufacturer serving appliance makers pointed to the weak economy but then specifically pointed to appliance industry plant shutdowns.

► When proving abnormal obsolescence, use symptoms of obsolescence (e.g. slowed

production volume) to prove causes of obsolescence, but do not attempt to pass symptoms

• ff as actually being the causes.

21

QUANTIFYING

Bob Weigel, McGladrey LLP

QUANTIFYING OBSOLESCENCE, EVALUATING TIME NEEDED IN ANALYSIS

Summary Of Logical Progression

• Does obsolescence exist?
• Can it be quantified?
• What data are accessible?
• What data are relevant?

What data are relevant?

• What is the complexity of the issue?
• How complex is the analysis?

Wh t i th l l f d d th l ti

• What is the level of exposure, and do the assessor or valuation

professional have experience in this type of obsolescence?

• Would an outside professional be beneficial?
• How can an argument be made using the data?
• Decide on a reasonable threshold for investment on this
• bsolescence analysis

23

Does Obsolescence Exist?

• Obsolescence is not a search for a Sasquatch in order to

reduce value.

• Hunches and gut reactions need not apply?

g pp y

• “We could never sell it for that much!”
• Proof of existence, like all existence questions, resides in the

evidence.

24

Quantification Is Essential

• Can it be quantified? If not, does it exist?
• The basis of all valuation is evidence. Since values are derived

from data, quantification is essential. from data, quantification is essential.

• Data lines: Cable vs. fiber optic
• What is better? Is there obsolescence?
• What is better? Is there obsolescence?
• 1 terabyte of data sent 1 linear ft (1,000ft)
• Time?
• Megabytes per second?
• Data limits?

25

What Data Are Accessible?

• Market data (general and specific)
• Industry data
• Government statistics
• Internal data

Internal data

• Commodity markets
• Equipment specifications

T h l i l I ti

• Technological Innovations
• Machine capacity

26

Examples Of Readily Available Data

• Market data
• Demand for product (national, regional, local)
• Market share

M k t t d

• Market trend
• Equipment dealers
• Equipment specifications

Equipment specifications

• Upcoming technological advances in equipment
• Cost
• Equipment comparisons

27

What Data Are Relevant?

• Is it relevant?
• Does it, or can it, apply to the specific asset or group of assets?
• Relevant? Sales declined by 35% over last year

Relevant? Sales declined by 35% over last year

• Relevant? Steel prices increased 64% over the last 18 months.
• Relevant? There is a 90-day waiting period for brass ingots.

R l t? O l id ff 12% f kf l t

• Relevant? Our company laid off 12% of our workforce last

quarter.

• Understand what items are included and excluded in the data
• Relevant? Gross domestic product increased by 3% in 2011.

28

Example: Company OLD

• Machine A, originally purchased in 2010 for $500,000, had a

production capacity of 1,000 units per day. A malfunction currently limits operating capacity to 900 units per day.

• Machine A is the current model of machine, with a current cost
• f $450,000.
• The malfunction is curable for $100,000.
• Due to a decreased market demand Machine A is currently
• Due to a decreased market demand, Machine A is currently

producing 850 units per day. Demand for this product is not expected to change.

29

Example: Company OLD (Cont.)

• What data are irrelevant?
• The $100,000 cost to cure the malfunction is irrelevant. Due

to current market demand and expected trends, it would not be beneficial to correct the malfunction.

30

Simple Issue Requires Simple Solution; Complex Issue May Require Simple Solution p y q p

• What level of exposure does the assessor or valuation

professional have related to this type of obsolescence?

• Increased complexity leads to decreased understanding.

p y g

• One may sound knowledgeable, but …
• Explain to a child why color exists
• Rods cones 1 billion cells refraction of light?
• Rods, cones, 1 billion cells, refraction of light?
• Receptors, light recognition, photosynthesis
• Concepts supported by data

31

Do We Need Help?

• Appraisers
• Mathematicians/actuaries
• Engineers
• Accountants

Accountants

• Attorneys

H l i t l d d

• Help is not always needed.

32

Paint The Picture With Data

• How can the argument be made using the data?
• Tell the story of data and the effects of the data.
• Color by numbers
• Sprinkle check repeat

Sprinkle, check, repeat

• Do not drown people with data
• Know their background and information tolerances

R d th i b d l

• Read their body language
• Are they listening?
• Do they understand?

33

Does The Investment Justify The Cost?

• Cost/benefit
• Strategic Importance
• Is there a possibility to leverage the outcome?
• Over-investment and “making it personal”

Over investment and making it personal

• Knowing when the rabbit should go free
• Decide on a threshold
• Thresholds can be singular, tiered, phased or any reasonable

approach.

34

OBSOLESCENCE CASES AND

Todd Barron, Barron Corporate Tax Solutions

COMMON ARGUMENTS FROM ASSESSORS ASSESSORS

Accrued Depreciation Accrued Depreciation

Loss in value from all of the causes of deterioration and obsolescence (physical, functional and external) = The difference between an asset’s cost new and its fair market value

36

Blower Being Assessed Blower Being Assessed

37

New Blower New Blower

38

Why accrued d i i ? depreciation? The asset being i d i appraised is not new. not new.

39

Accrued Depreciation Accrued Depreciation

Central question: What is “wrong” with the asset being assessed that would cause a willing What is wrong with the asset being assessed that would cause a willing buyer to pay less for it than for a new asset?

40

Accrued Depreciation (Cont.) Accrued Depreciation (Cont.)

Necessary explanation: Be prepared to “tell your story” in order to effectively explain the issues that Be prepared to tell your story in order to effectively explain the issues that are leading to your obsolescence and why that obsolescence would cause a willing buyer to pay less for your property.

41

Obsolescence Case Studies

42

Case I: Powering Down Case I: Powering Down

Industry and property facts

• Unique electric battery production plant with specifically designed

equipment - no alternate use

• U.S. manufacturing plant constructed in 19XX

– Capacity approximately 1.2 million units per year – Older platform of production technology

• Sister plant built in Mexico in 20YY
• Sister plant built in Mexico in 20YY

– Global demand expected to exceed 3.0 million units per year – Capacity more than 2.0 million units per year N l f f d i h l – Newer platform of production technology

43

Case I: Powering Down (Cont.) Case I: Powering Down (Cont.)

Industry and property facts (Cont.)

• Global demand did not meet expectations at only 1.75 million units per

year.

• Company decided to close the U.S. plant.

– Decision to keep the plant in Mexico with newer technology and higher capacity to manage future global demand – Announcement made in Nov. 20XX, and plant closed by the end , p y

• f Jan. 20XY. As of Jan. 1, plant operating at only 30% to 40%.
• Some equipment sent to Mexico, but most was scrapped, with proceeds

less than $100,000.

44

Case I: Powering Down (Cont.) Case I: Powering Down (Cont.)

Obsolescence issues to consider

• Older U.S. equipment is not as technologically advanced, creating

functional obsolescence.

• Decrease in market demand is creating external obsolescence based on

global demand.

• Equipment has few alternative uses because it is product-specific,

without many competitors.

• Willing buyer would not pay for the outdated technology, nor for the

excess capacity.

45

Case I: Powering Down (Cont.) Case I: Powering Down (Cont.)

Valuation options to consider

• Value assets as scrap at 5% or 10% of cost
• Value assets using age/life depreciation calculation with 1 year remaining

life (i.e. 14/15 = 93%)

• Value assets using floor of county’s valuation schedule at 15% of cost

for most assets

• Use cost-to-capacity model based on demand to determine obsolescence

p y

46

Case I: Powering Down (Cont.) Case I: Powering Down (Cont.)

Taxpayer’s case and outcome

• Taxpayer explained issue and resulting obsolescence.
• Appraiser was retained to value assets for 20XY tax year.

– Valued assets were transferred to Mexico at 20% of cost new. – Valued assets were scrapped at 10% of value, after application of county’s tables to reported costs.

• Actual scrap information was not considered by appraiser or court since
• Actual scrap information was not considered by appraiser or court, since

after assessment date and no sales data existed for similar assets

• Taxpayer lost in court in a bad decision.

47

Case II: Crashing Demand Case II: Crashing Demand

Industry and property facts

• Automotive manufacturing facility in TN designed to produce parts for

460,000 vehicles annually

• Actual production was 302,000 in 20XX and only 112,000 in 20XY, due

to decline in industry demand.

• Company took a FAS 144 write-down to zero for the production assets

at the facility (adjustment of approximately $1,675,000 to NBV).

48

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Obsolescence Issues to Consider

• Market conditions impacted demand for product

produced by the unique assets p y q

• Willing buyer would not want to pay for all of the

available capacity since the market limits utilization p y

• Willing buyer would require a reduction in value to

account for the increased risk of owning these assets given the demand expectations

49

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Valuation options to consider

• Use cost-to-capacity technique to determine external obsolescence in the

cost approach

• Use income approach to show decline and compare with the cost

approach

• Consider FAS 144 adjustment to accounting records as a proxy for

valuation adjustment, after applying jurisdiction’s cost approach

50

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome

• Taxpayer explained issue and resulting obsolescence, and their impacts
• n value.
• Used cost-to-capacity technique to determine external obsolescence
• Presented results in conjunction with FAS 144 adjustment to accounting

records

51

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.) Cost-to-capacity analysis Obsolescence (%) =

• [ 1 – (Capacity A / Capacity B)n] x 100
• Capacity A = actual production

Capacity B = rated or design capacity l f

• n = scale factor

52

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.) Cost-to-capacity analysis Designed capacity 460,000 Actual capacity 112,000 Industry service factor 70 Industry service factor .70 Highest recent capacity 398,000

53

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.) Cost-to-capacity analysis Obsolescence (%) = /

70

• [ 1 – (112,000 / 460,000).70] x 100
• Obsolescence (%) = 62.80%, rounded to 60%

54

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.)

• Suggested to use FAS 144 write-down in 20XY as proxy for value

adjustment to value, when jurisdiction's tables applied to costs Asset cost reported $6,947,200 Value after application of tables $3,279,100 FAS 144 adjustment $1 675 000 FAS 144 adjustment $1,675,000 Proposed value $1,604,100

55

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.)

• Suggested cost-to-capacity obsolescence adjustment in 20XZ against

resulting value, after applying jurisdiction’s tables Asset cost reported $9,876,600 Value after application of tables $2,950,200 Cost-to-capacity adjustment (60%) $1 770 000 Cost to capacity adjustment (60%) $1,770,000 Proposed value $1,180,200

56

Case II: Crashing Demand (Cont.) Case II: Crashing Demand (Cont.)

Taxpayer’s case and outcome (Cont.)

• Neither approach was accepted in total by the assessor or state

representative.

• Global resolution was reached for both tax years involving other

appealed issues as well.

57

Case III: Bad Headache Case III: Bad Headache

Industry and property facts

• Chemical plant was the last facility in the U.S. producing an aspirin-

related product.

• Due to international competition and high production costs, the

company announced in 20XX that the plant would be closed at the end

• f 20XY, and production shifted to lower-cost facilities.
• Company took a FAS 144 write-down, since the plant would close prior

to the end of its normal life.

58

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Item Q4, 20XX Q1-Q4, 20XY Net Sales $4,952,000 $20,583,000 Contribution @ Standard $2,798,000 $10,856,000 Fixed Costs

• $1,472,000
• $6,975,000

Depreciation

• $471,000
• $1,889,000

Direct Allocation to Plant

• $55,000
• $150,000

Manufacturing Allocations

• $26,000
• $104,000

Gross Margin $774,000 $1,738,000 Direct Selling Expense

• $533,000
• $2,144,000

Taxes

• $99,000

$166,000 , , Estimated Capital Expense

• $125,000
• 0-

Cash Flow $488,000 $1,649,000

59

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Obsolescence issues to consider

• High production costs and international competition create
• bsolescence.
• Willing buyer would not want to invest, given the cost structure at the

facility.

• Willing buyer would require a significant reduction in value to account

for the increased risk of owning these assets, given the issues.

60

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Valuation options to consider

• Determine present value of excess operating costs over remaining life of

the plant

• Use cost-to-capacity technique to determine external obsolescence in the

cost approach

• Use income analysis to show decline, and compare with the cost

approach conclusion

• Consider FAS 144 adjustment to accounting records as a proxy for

valuation

61

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Taxpayer’s case and outcome

• Taxpayer explained issue and resulting obsolescence, and their impacts
• n value.
• Used discounted cash flow from FAS analysis to determine external
• bsolescence
• Presented results in conjunction with FAS 144 adjustment to accounting

records

62

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Taxpayer’s case and outcome (Cont.) FAS 144 - Discounted cash flow analysis Interest rate (w/risk) 8% [ x ÷ (1+i) n] = [488 000 ÷ (1 + 8%) .25] = 478 700 [ x ÷ (1+i) n] = [488,000 ÷ (1 + 8%) .25] = 478,700 = [1,649,000 ÷ (1 + 8%) 1.25] = 1,497,756 Total present value = $1,976,500 (rounded)

63

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Taxpayer’s case and outcome (Cont.) FAS 144 - discounted cash flow analysis Carrying amount (NBV) = $15,916,000 Total present value = $1 976 500 Total present value = $1,976,500 Impairment loss = $13,939,500 (NBV less PV)

64

Case III: Bad Headache (Cont.) Case III: Bad Headache (Cont.)

Taxpayer’s case and outcome (Cont.)

• Reported cost for 20XX was $25,000,000, with corresponding value of

$10,575,000 after applying jurisdiction’s valuation methodology.

• Final value after presentation of FAS 144 adjustment and income

analysis was $4,000,000.

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Case IV: Left In The Dust Case IV: Left In The Dust

Industry and property facts

• The Environmental Protection Agency (EPA) passed new regulations

for disposing of arc furnace dust from steel mills, necessitating a new process.

• A British company began construction of a plant in TX to service the

disposal requirements of a large steel mill in the area.

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Case IV: Left In The Dust (Cont.) Case IV: Left In The Dust (Cont.)

Industry and property facts (Cont.)

• The recovery method was experimental, and the company spent four

years and $70 million on the facility trying to perfect it.

• The EPA reversed itself and rescinded the regulation, thus leaving no

market or use for the newly developed processing facility.

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Case IV: Left In The Dust (Cont.) Case IV: Left In The Dust (Cont.)

Obsolescence issues to consider

• The technology was new and unproven, and some of the cost was for a

“learning curve.”

• Lack of demand essentially eliminated the opportunity to earn return on,

and of the initial investment in, the project.

• Change in government regulations significantly increased the risk profile
• f the project.

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Case IV: Left In The Dust (Cont.) Case IV: Left In The Dust (Cont.)

Valuation options to consider

• Consider replacement cost if built now
• Use cost-to-capacity technique to determine economic obsolescence
• Use income approach to show loss in value

pp

• Consider salvage value for the assets

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Case IV: Left In The Dust (Cont.) Case IV: Left In The Dust (Cont.)

Taxpayer’s case and outcome

• Year 1 & 2: Valued based on construction in progress at reduced levels
• Year 3: The county appraisal district refused to recognize the serious
• bsolescence issues.
• Year 4: The EPA’s cancelation of its regulation and resulting external
• bsolescence came into play.

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Case IV: Left In The Dust (Cont.) Case IV: Left In The Dust (Cont.)

Taxpayer’s case and outcome (Cont.)

• Over the four years of development, the assessment had risen to a high
• f $23 million and dropped to an eventual low of $2 million, based on
• bsolescence.
• The final assessment was an amount reached in litigation negotiations

and was based on a salvage value of $750,000, recognizing the EPA’s decision.

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Assessor Arguments

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

1st argument: Replacement cost new, less physical depreciation (RCNLD) includes ll f f d d i i all forms of accrued depreciation.

• Response: Percent good tables cannot capture excessive functional
• bsolescence or economic obsolescence. Instead, they are a “best case”

scenario, in which the property is assumed to function fully for its intended purpose, and no external forces are impairing its value.

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

2nd argument: Any obsolescence recognition would create a uniformity issue, when d i h h d h i i compared with other taxpayers and their properties.

• Response: Failure to recognize obsolescence creates the very inequities they

seek to avoid. Physically, functionally or economically disadvantaged properties will pay a disproportionately higher share of the tax burden if they are appraised as if no issue exists.

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

3rd argument: A lack of information and/or difficulty in quantifying economic b l i RCNLD (li i d h i l d i i ) h

• bsolescence necessitates an RCNLD (limited to physical depreciation) approach.
• Response: When an appraiser is aware of an impairment to the value of a

t th t i h th ibilit t ti t f i k t property, that appraiser has the responsibility to estimate a fair market value reflective of the property in its current condition (difficulty is not an excuse to disregard).

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

4th argument: The obsolescence is temporary; therefore, no further adjustments are necessary.

• Response: Would a willing buyer in the current market disregard the

b l ld th t b f t i th it ti h i

• bsolescence, or would that buyer factor in the situation when paying a

particular price for the property? If the willing buyer’s actions are affected by the obsolescence, then the appraiser must adjust the property tax valuation accordingly. g y

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

5th argument: For many types of equipment, use is limited, and we do not adjust h l f idl i Th f f f h l dj i those values for idle time. Therefore, your request for further value adjustment is unreasonable. R S i b i i d i l d h illi

• Response: Some equipment, by its nature, is used sparingly, and the willing

buyer factors that reality into the initial price paid. Example: A farm combine is expected to work only several weeks per year. That is not the same situation as a manufacturing facility, which is intended for year-round g y, y use.

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Assessor Arguments (Cont.) Assessor Arguments (Cont.)

• Utilize standard valuation approaches; but, remember the assessor is in a

i l hi h l b i mass appraisal, high volume business

• Increase your chance for success by making your case as clear, concise

and compelling as possible

• Explain what is causing the obsolescence and why a willing buyer would

pay less because of it

• Provide good evidence and sound calculations, but be willing to

compromise

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