A taxable possessory interest (PI) is created when real estate owned by a government agency is leased, rented, or used by a private individual or entity for their own exclusive use. The taxation of this interest is similar to the taxation of owners of privately owned property. A taxable possessory interest may be created or acquired through a contract, lease, concession agreement, license, permit, verbal agreement, or simply by possession or occupation without agreement. The use of the property may be concurrent or alternating with another use or user.
VALUING TAXABLE POSSESSORY INTEREST
A base year value is established for taxable possessory interest upon its creation, a change in ownership, or completion of new construction under the guidelines of Proposition 13. This value, by law, will only increase by a maximum of 2% per year, until a new reassessable event (change of ownership or completion of new construction) occurs, or the property suffers a decline-in-value. For an expanded definition see Revenue and Taxation (R&T) Code Section 61, 107-107.9, 480.6 and Property Tax Rules 20,21-22, and 27-28 available online at http://www.boe.ca.gov/proptaxes/proptax.htm. A change in ownership occurs when a possessory interest is created, assigned, or upon the expiration of the lease per Revenue & Taxation Code Section 61 available online at http://www.boe.ca.gov/proptaxes/proptax.htm.
The valuation of possessory interests is different from other forms of property tax appraisal in two ways:
Only the rights held by the private user are valued
The assessor must not include the value of the lessor’s retained rights in the property or any rights that will revert back to the public owners (the “reversionary interest”) at the end of the lease.
As a result, possessory interest assessments are frequently less than the assessments of similar privately-owned property.
When a new base year value is computed for a possessory interest property, the Assessor uses the income, comparative sales, or cost approach. The quality and quantity of the available market information, the type of interest being valued, and the estimated reasonable term of possession will determine which of the three valuation approaches is most appropriate to use.
This is the most commonly used method for valuing a possessory interest. Using this approach, the PI value is estimated by first determining the landlord’s net income over the entire contract term. The net income results from subtracting management expenses from the economic income. The net income is then multiplied by a present worth factor to arrive at the PI value. Using the economic net income for the term of possession allows the Assessor to value only the rights “possessed” by the tenant and exclude any non-taxable rights retained by the government landlord.
Comparative Sales Approach:
In this approach to value, the sales price of the property and those of similar possessory interest properties are used to determine possessory interest value. Rent paid on the property and any other obligations assumed by the buyer are valued at present worth and added to the sales price.
In the cost approach, the land and improvement values are determined separately. The land value is determined using the comparative sales approach or the income approach. Consideration is given for the reversionary value of the land at the end of the anticipated term of possession. The improvement value is estimated by estimating replacement cost new and subtracting the accrued depreciation. Consideration is given for the estimated value of the improvements at the end of the anticipated term of possession. The total value of the PI is determined by adding the estimated land value to the estimated improvement value.
Examples of Possessory Interests:
A boat dock built on a public lake, bay or river;
Private companies leasing government buildings
The right to have food vending machines or ATMs located in a government building
The valuation approaches for taxable possessory interests are similar to the conventional approaches to value – the comparative sales approach, the income approach, and the cost approach – that are generally accepted and used in the valuation of a fee simple interest. However, the conventional approaches must be modified to accommodate the finite duration of a taxable possessory interest and the corresponding fact that a portion of the fee simple interest in those rights, the reversionary interest, is retained by the government owner and is non-taxable. While any of the sales comparison, income, or cost approaches to value may be used by the Assessor in valuing taxable possessory interests, the income approach is the most commonly relied upon method of valuing them. In the income approach, a taxable possessory interest is valued by discounting the future net income that the interest in real property is capable of producing during the anticipated term of possession. Where both economic rent and a reasonable term of possession can be determined, estimating the PI value involves capitalizing the potential rental income stream (less anticipated vacancy, collection loss and management expense from a landlord's point of view). The resulting figure is the value of the taxable Possessory Interest. Capitalizing the economic net income for the term of possession measures only those rights possessed by the tenant and excludes any non-taxable rights retained by the governmental landlord. A term of possession for the taxable possessory interest must be determined, using such evidence as the actual contract or rental agreement itself, any history of prior use by the current tenant, the government entity's current policies, or the history of other past or current tenants’ use of the same or similar rights to determine a reasonable term of possession. It is not uncommon for holders of Possessory Interests to construct facilities on the leased property that will revert to the government owner when the lease expires. In that case (presuming actual rent is economic rent), the valuation of the taxable possessory interest rights using an income approach should reflect both the actual rent plus an imputed rent for the added improvements for the term of possession, or, the actual rent plus the value of the leasehold improvements built by the tenant. Capitalization rates used in PI assessments reflect the landlord's perceived risk and are typically derived from sales of similar fee-owned properties. These derived rates are then adjusted to further reflect those risk considerations specific to each individual Possessory Interest situation.
The valuation of Possessory Interests (PIs) differs significantly from other forms of property tax appraisal in that it is the appraiser's job to value only those rights held by the private possessor. The appraiser must not include the value of any rights retained by the public owner or any rights that will revert back to the public owner (the "reversionary interest') at the end of the term of possession. As a result, Possessory Interest assessments are normally less, and often significantly less, than fee simple assessments of similar, privately-owned property.
The payment schedule for unsecured roll tax bills is significantly different than for secured roll tax bills and taxpayers should be aware of that difference. Unsecured bills are due and payable in full no later than August 31 each year. If paid after August 31, a penalty of 10% plus costs will be added to the amount due. Unsecured bills are not split into two installments with two different delinquency dates, as is true of Secured Roll tax bills.
In order to establish whether such a use is subject to local property tax, the nature of the use must be analyzed to determine whether it meets certain specific requirements of the law set forth in Revenue & Taxation Code Section 107 and Property Tax Rules 21 through 28. In the simplest of terms, for a Possessory Interest to be taxable, it must be: Exclusive: Its holder must be able to exclude others from interfering with the use of the property, (or, where there is concurrent use, the concurrent use does not significantly interfere with the holder's use). Independent: The use must be independent of the public owner. That is, its holder may exercise authority and control of the property apart from the rules and regulations of the public owner. Durable: There must be reasonably certain evidence to show that the possession will continue for a determinable period of time.
In some cases, government owned property outside the boundaries of its jurisdiction is taxable under Section 11 of Article XIII of California's Constitution. Though not a common circumstance, government owners sometimes rent portions of their Section 11 properties to private tenants. The procedure specified in the law for valuing Section 11 property recognizes both taxable and non-taxable interests in such property. In other words, Section 11 property is both partially tax exempt and partially taxable. It is the tax-exempt portions of those properties that are subject to Possessory Interest taxation when they benefit a private tenant. Private tenants in Section 11 properties have a taxable Possessory Interest in a proportionate share of the difference between "Market" value and Section 11 value. In other words, although some of the government owned rights in a Section 11 property are taxed, a Possessory Interest may exist in the portion of those rights that have been exempted from taxation under the mechanism provided in Section 11.
Those who receive Possessory Interest assessments are often puzzled and perplexed by the apparent paradox of on the one hand paying rent to a government entity and on the other being asked to pay property tax as well. The explanation is that government entities do not have to pay property tax and thus their rent charges do not include an increment to recover such taxes. At the same time, the private possessor still receives the services and benefits (fire and police protection, schools and local government) that other similar taxable properties enjoy. The Possessory Interest tax helps to pay the holder’s share of those costs. Possessory Interest rents reflect only the public's return on its investment and do not include a property tax component. On the other hand, private sector rents include both the owner's return on investment and a property tax component to recover those taxes. As such, the separate collection of Possessory Interest tax does not result in double taxation.
Possessory Interests are normally assessed on the Unsecured Tax Roll because the property rights being assessed are not owned by the assessee and cannot provide security for the taxes owed. In other words, the county cannot seize the property in order to satisfy any delinquent property tax. Therefore, PI’s are assessed as real property on the Unsecured Roll. It is possible for a PI to be assessed on the secured roll but only in a situation where the Assessor agrees that property (buildings) built by a tenant on the publicly-owned land is by itself sufficient security for the taxes owed.