Keeping It Real…Or Personal: With Property, What’s the Difference? State and Local Tax

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Keeping It Real…Or Personal: With Property, What’s the Difference?

Keeping It Real…Or Personal: With Property, What’s the Difference?

Knowing and understanding how to classify real estate, personal property and fixtures for property taxation purposes requires the knowledge of which rules apply. The difficult part of the exercise is the rules that apply can vary on a state-by-state and, in some cases, on a local basis.

For those that could use a refresher: Real estate is generally classified as assets that are permanently attached to land such as a house, garage or outbuilding. Conversely, if an asset is movable, then it would often be classified as personal property. In simplest terms, anything that is movable is often classified as personal property, while the immovable is classified as real estate.

Unfortunately, the simplest terms don’t always apply. For instance, a typical definition of real estate or real property, per the Property Tax Code, may read like this: “The land itself, with all things contained therein, and also all buildings, structures and improvements, and other permanent fixtures thereon….” The murkiness begins with the terms “improvements, and other permanent fixtures thereon.”

What’s Required to Know the Difference?

The most important thing to know is that state statutes vary considerably in their definitions of different categories of property for different purposes. So, whenever the categorization of property makes a difference in legal rights or remedies, you should first search for relevant statutory definitions.

The catch is, in order to protect your financial interests as they relate to property identification, you must become an expert in two rather technical areas:

  • Precedent case law and historical assessment practices for the jurisdiction of the property in question, so you can properly identify real vs. personal property
  • The ability to perform a cost-benefit analysis as it relates to reclassifying real property to personal property, and vice versa to determine its impact on assessed value and associated property taxes

Once you have these capabilities, your first step is to identify how and why the distinction between personal property and real estate might matter. Ask yourself:

  • Is the asset taxable or exempt property? Is it subject to non-tax assessments?

Most states initially taxed all tangible property-real estate and personal property/fixtures. The most recent trend has been to only tax assets classified as real estate. In real estate-only states, “bright-line” tests (or rules) used to distinguish real vs. personal property have generally been developed by case law or administrative decisions/promulgated rules. A bright-line test is a clearly defined rule or standard held in the U.S., composed of objective factors that leave little or no room for varying interpretation. The purpose of a bright-line test is to produce predictable and consistent results in its application.

  • Will the classification of the asset impact the calculation of depreciation?

Real estate generally depreciates at a slower rate than personal property due to shorter physical lives and higher susceptibility to obsolescence. The key objective in the classification exercise is to maximize depreciation to minimize taxable value.

  • Are there any errors that can lead to omitted property or double taxation?

The numerous parties involved in the assessment process combined with the uncoordinated methods used to establish what is real estate (i.e., assessing officials, cost manuals and sales transactions) and what is personal property (taxpayers and auditors) can produce erroneous results. This is especially true with leasehold improvements because whomever pays for them, owns them, reports them and decides how they are incorporated in a tenant’s rental rate can complicate issues.

Per the California Assessor Handbook 504: “Thus, care must be taken to properly classify improvements as structure items or fixtures. The danger with respect to improper classification of an item is that it could become subject to double assessment or may escape assessment.”

Also, it’s vital to be aware of other contexts in which the distinction of property classification arises, such as:

  • Cost Segregation: Federal Income Tax - 1245 (personal) and 1250 (real) property
  • Lending/Underwriting/Foreclosure:  UCC Article 9 (personal property) definition of fixture defers to local real property law
  • Condemnation
  • Landlord-Tenant Relations

Because there may be “a wilderness of authority on this question…and a hopeless conflict of decision,”1 it would be productive to take a cue from Teaff vs. Hewitt2 and perform the three-part test for making the distinction between real and personal property:

  • Actual annexation to the realty, or something appurtenant thereto;
  • Appropriation to the use or purpose of that part of the realty with which it is connected; and
  • The intention of the party making the annexation to make the article a permanent accession to the freehold

For help with any questions regarding how to categorize your assets and the property tax implications therein, contact the Duff & Phelps Property Tax Services practice.

Sources
1.Philadelphia Mortgage & Trust Co. v. Miller, 20 Wash. 607, 610 (1899)
2.Teaff v. Hewitt, 1 Ohio St. 511, 529-30 (1853)

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