ATTORNEYS FOR PETITIONER: ATTORNEYS FOR RESPONDENT:
MARC A. HETZNER JEFFREY A. MODISETT
FRANK A. HOFFMAN Attorney General of Indiana
MICHAEL J. MESSAGLIA Indianapolis, Indiana KRIEG DeVAULT ALEXANDER &
CAPEHART ANGELA L. MANSFIELD
Deputy Attorney General
PEDCOR INVESTMENTS-1990-XIII, L.P., ) ) ) Petitioner, ) ) v. ) Cause Nos. 49T10-9602-TA-00017 ) 49T10-9609-TA-00103 STATE BOARD OF TAX COMMISSIONERS, ) ) Respondent. ) _____________________________________________________________________
ON APPEAL FROM FINAL DETERMINATIONS OF THE STATE BOARD OF TAX COMMISSIONERS_____________________________________________________________________
Pedcor's 13-acre, 160-unit apartment complex as of the March 1, 1992 and March 1,
1993 assessment dates.
assessments by filing two Form 130 petitions (one for the March 1, 1992 assessment
and one for the March 1, 1993 assessment) with the Johnson County Board of Review
(BOR). Unsatisfied with the BOR's disposition of those petitions, Pedcor filed two Form
131 petitions with the State Board challenging the BOR's findings for each assessment
In both Form 131 petitions, Pedcor alleged that the apartment complex suffered from obsolescence due to the requirement that 44% of the rental units be leased to lower-income tenants and the effect that requirement had on the marketability of the remaining rental units. In addition, Pedcor alleged that the apartment complex was incorrectly graded and that the land value was excessive when compared to allegedly similarly situated apartment complexes. See footnote 4 In the Form 131 petition challenging the March 1, 1992 assessment, Pedcor alleged that, because the apartment complex was vacant on the March 1, 1992 assessment date, the apartment complex suffered obsolescence on that date and a one-time obsolescence adjustment should have been made. The State Board held two separate hearings on these Form 131 petitions. On January 12, 1996, the State Board issued its final determination for the March 1, 1992 assessment date, and on July 26, 1993, the State Board issued its final determination for the March 1, 1993 assessment date. Pedcor then filed an original tax appeal for each State Board final determination. These appeals were consolidated. See Ind. T.R.
42(A). Both parties have filed summary judgment motions.
1994). Under the regulations, obsolescence depreciation represents a functional and economic loss of value. Ind. Admin. Code tit. 50, r. 2.1-5-1; see also Loveless Constr. Co., 695 N.E.2d at 1047. The functional component of obsolescence depreciation is caused by factors internal to the property and is 'evidenced by conditions within the property.' Clark, 694 N.E.2d at 1238 (quoting Ind. Admin. Code tit. 50, r. 2.1-5-1); see also Western Select Properties, 639 N.E.2d at 1070-71 (Functional obsolescence is a form of depreciation resulting in loss of value due to lack of utility or desirability inherent in the design of the property.) (quoting Institute of Property Taxation, P ROPERTY T AXATION 114 (Jerrold F. Janata ed. 2d ed. 1993)); Michael D. Larson, Identifying, Measuring, and Treating Functional Obsolescence in an Appraisal, J. Prop. Tax Mgmt., Spring 1999, at 44. There are numerous possible causes of functional obsolescence, e.g., inefficient floor plans, unnecessary or superadequate construction, inadequate parking, and mechanical inadequacy. See Ind. Admin. Code tit. 50, r. 2.1-5- 1; id. r. 2.1-6-1 (1992) (codified in present form at id. r. 2.2-1-40 (1996)). The economic component of obsolescence depreciation is caused by factors external to the property. See id. r. 2.1-5-1. Possible causes of economic obsolescence include: Inoperative or inadequate zoning ordinances or deed restrictions and Market acceptability of the product or devices for which the property was constructed or is currently used. Id. Pedcor contends that for both the 1992 and 1993 assessments, the apartment complex should have received an obsolescence adjustment. For both
assessments, Pedcor contends that the State Board failed to consider evidence that the
deed restrictions on the property and the decreased market acceptability of the
apartment community as a whole were causes of economic obsolescence. For the
1992 assessment, Pedcor contends that the State Board should have applied a one-
time obsolescence adjustment due to the vacant state of the property on the
For ease of analysis, the Court will first address the deed
restrictions and the alleged decreased market acceptability for the 1992 and 1993
assessments. The Court will then address whether the apartment complex should have
received a one-time obsolescence adjustment.
lower-income tenants makes the other 56% of the rental units less desirable. Pedcor maintains that an additional 5% obsolescence adjustment is warranted for this reason. See footnote 7 In its final determinations, the State Board did not accept Pedcor's contention that an obsolescence adjustment was warranted due to the deed restrictions. In the final determination for the 1992 assessment, the State Board concluded that the deed restrictions d[id] not fall within the definition of obsolescence because they did not constitute an external influence which affects the usage and operation of the property. (State Bd. 1992 Final Determination ¶ 3). The final determination for the 1993 assessment contains a somewhat different analysis: The evidence along with a review of the area found a lack of market acceptability is not demonstrated. The restrictions as detailed in the evidence are not sufficient justification to support a significant reduction in value. (State Bd. 1993 Final Determination ¶ 3). In its representations to the Court, the State Board elaborates on these findings and has altered its stance to a certain degree. While maintaining its position that the deed restrictions cannot constitute economic obsolescence because they are not external to the property, the State Board also points to the fact that Pedcor receives a number of federal tax incentives as a result of the deed restrictions and argues that these tax incentives make up for any loss in rental income resulting from the deed restrictions. Additionally, the State Board notes that Pedcor voluntarily placed the deed restrictions on the property and that
Pedcor voluntarily chose to attract low-income tenants and, therefore, in the State
Board's view, cannot complain about the decreased market acceptability of its
In essence, the State Board challenges Pedcor's claims of
economic obsolescence on three grounds: 1) the deed restrictions cannot constitute
economic obsolescence under the definition of economic obsolescence; 2) by entering
into the deed restrictions, Pedcor caused any economic obsolescence suffered by the
apartment complex, thereby making an obsolescence adjustment unwarranted; and 3)
any loss of rental income is made up by the federal tax incentives.
The State Board's first and second challenges to Pedcor's obsolescence claims lack merit. Under the regulation governing obsolescence, economic obsolescence can be caused by deed restrictions. See Ind. Admin. Code tit. 50, r. 2.1-5-1. As a result, the State Board cannot credibly argue that the definition of economic obsolescence on its face excludes the deed restrictions setting aside 44% of the rental units in the
apartment complex for low-income tenants.
Perhaps the State Board's apparent confusion on this point results from language in the regulation stating that economic obsolescence is caused by factors external to the property. A deed restriction is, of course, part of the property itself; so how, one might ask, can it be that a deed restriction can be an external factor causing economic obsolescence? The answer is that the external factor is not the deed restrictions per se, but rather the marketplace's reactions to them. As times change, a deed restriction that at one time enhanced the value of a particular property may make that property less valuable as a result of changing external conditions. As the State Board recognizes in its regulations, this is a cause of economic obsolescence.
The State Board's second challenge has some surface appeal. Although a property owner can reduce a property's value by imprudently agreeing to deed restrictions and cause himself economic loss, a property owner should not be allowed to reduce the tax base in such a manner. Cf. Lake County Trust No. 1163 v. State Bd. of Tax Comm'rs, 694 N.E.2d 1253, 1258-59 (where property owner entered into unfavorable lease, obsolescence adjustment was not warranted because there was nothing inherently wrong with the property itself), review denied. Consequently, the State Board may properly determine that an obsolescence adjustment is not warranted in situations where a property owner imprudently agrees to a deed restriction on his property. However, the State Board goes further. In the State Board's view, any time a
property owner enters into a deed restriction, no obsolescence would be warranted
because the decision to enter into the deed restriction was within the property owner's
control. This simply goes too far. A deed restriction that causes property to lose value
as economic conditions change does not have a different effect on the value of that
property merely because it was the property owner that entered into the deed restriction
in the first place. Therefore, the State Board cannot point to the mere fact that Pedcor
entered into the deed restriction to support a denial of economic obsolescence.
The State Board's third challenge to Pedcor's obsolescence claims meets with more success. The apartment complex is an income-producing property. As a result, from an economic standpoint, its value is tied to its ability to produce income. See Simmons v. State Bd. of Tax Comm'rs, 642 N.E.2d 559, 560 (Ind. Tax Ct. 1994) (quoting Appraisal Institute, The Appraisal of Real Estate 409 (10th ed. 1992)). The deed restrictions, because they lower the rent of 44% of the rental units, affect the income-producing ability of the apartment complex and thus its value. As a result, if one considers the deed restrictions' effect on the rental income generated by the apartment complex in isolation, one might well conclude that the deed restrictions cause the apartment complex to suffer economic obsolescence. See footnote 9 See Loveless Constr.
Co., 695 N.E.2d at 1050 (obsolescence linked to decrease in a property's income
generating ability); Clark, 694 N.E.2d at 1238-39 (loss of rental income possibly
indicative of economic obsolescence).
That is where Pedcor would like the Court to end its analysis. However, as the State Board points out, the deed restrictions also allow Pedcor to take advantage of certain federal tax incentives. These tax incentives provide financial benefits to Pedcor's partners, thereby counteracting the decreased rental income. Accordingly, these federal tax incentives must be taken into consideration when evaluating whether the deed restrictions do, in fact, cause the apartment complex to experience economic obsolescence. See footnote 10
Pedcor's arguments to the contrary do not alter this conclusion. In Pedcor's view, the Court may not consider the effect of the federal tax incentives because these benefits ultimately go to Pedcor's partners, not Pedcor itself. See footnote 11 This argument is wholly unmeritorious. The deed restrictions create financial benefits, and these benefits cannot be ignored simply because they pass through to the partners (who, incidentally,
are jointly and severally liable with Pedcor for any unpaid property tax, see Ind. Code
Ann. § 6-1.1-2-5 (West 1989)).
Pedcor also contends that it is improper to consider the federal tax benefits in determining the economic obsolescence of the apartment complex because they are subject to recapture if the apartment complex no longer serves lower-income tenants. Therefore, according to Pedcor, any benefits from the federal tax incentives are speculative, and, therefore, are not probative of whether the apartment complex suffers economic obsolescence. This argument, too, is without merit.
Pedcor built the apartment complex to serve lower-income tenants and entered into the deed restrictions to take advantage of federal tax incentives designed to encourage private developers to build affordable housing for low to moderate income individuals. Apparently, Pedcor did not consider the benefits arising from the deed restrictions speculative when Pedcor decided to build the apartment complex because Pedcor actively sought out these benefits. Pedcor therefore can hardly be heard to argue that these benefits are speculative simply because they are subject to recapture if Pedcor fails to comply with applicable federal regulations. Moreover, Pedcor's argument that these benefits are speculative is based on Pedcor's own speculation that, at some point in the future, Pedcor will fail to comply with applicable regulations and thereby subject the federal tax benefits to recapture. As of the tax years at issue, Pedcor (or Pedcor's partners) had these federal tax benefits firmly in hand. These
benefits will not be ignored simply because Pedcor may release its grip on them in the
future. See footnote 12
Deciding that the federal tax benefits were a relevant consideration in determining the economic obsolescence of the apartment complex is not the end of the inquiry. The Court must also examine the propriety of the State Board's conclusion that the apartment complex did not suffer economic obsolescence during the tax years at issue. In arriving at its conclusion that the apartment complex did not suffer economic obsolescence, the State Board must have determined that the federal tax incentives made up for any loss in rental income caused by the deed restrictions, including losses due to the alleged decreased market acceptability and that, as a result, the deed restrictions did not actually cause the apartment complex to lose value. Without a loss of value, there can be no economic obsolescence. See Clark, 694 N.E.2d at 1238.
This was a rational conclusion from the evidence contained in the record. At the administrative hearings, Pedcor presented the State Board with evidence showing that the deed restrictions lowered the rental income that Pedcor would otherwise receive but also provided Pedcor with federal tax incentives that Pedcor would not have received but for the deed restrictions. In addition, although, as noted above, the mere fact that
Pedcor voluntarily sought out the deed restrictions is not dispositive of the issue of
economic obsolescence, it is likely that Pedcor would not have entered into the deed
restrictions if the federal tax benefits did not adequately compensate Pedcor for the
decreased rental income.
In order to overturn the State Board's conclusion that the federal tax incentives received by Pedcor made up for the loss in rental income in this original tax appeal, there must be unrebutted evidence in the record demonstrating that the federal tax incentives do not make up for the decreased rental income associated with the deed restrictions. See footnote 13 See id. at 1328-29 (where State Board rebuts taxpayer's prima facie showing of obsolescence, burden of going forward with evidence placed on the taxpayer). However, there is no such evidence in the record. As a result, the State Board's conclusion that the deed restrictions did not cause the apartment complex economic obsolescence must stand. See id. at 1239 (where taxpayer fails to carry burden of going forward with evidence, State Board's final determination will not be
case, the taxpayer complained that the State Board erred in finding that a defunct and
totally vacant property should receive a 75% obsolescence adjustment. The Court
agreed with the taxpayer and held that the State Board's quantification of the
obsolescence experienced by the defunct and totally vacant building at 75% was
unsupported by substantial evidence. See Western Select Properties, 639 N.E.2d
1073-74. From this holding, Pedcor deduces a rule that wherever there is total
vacancy, there is obsolescence. Therefore, under Pedcor's interpretation of Western
Select Properties, the State Board erred when it did not apply a one-time obsolescence
factor to account for the vacancy of the apartment complex on the assessment date.
Pedcor misreads the regulations and this Court's holding in Western Select Properties. Under the regulations, obsolescence depreciation is composed of functional and economic loss of value. Ind. Admin. Code tit. 50, r. 2.1-5-1. Accordingly, in order for an obsolescence adjustment to be made, there must be some loss in value. There is no such loss of value here. Pedcor points to the lack of income generating ability of the apartment complex on the assessment date. However, when the construction of the apartment complex began, there was no rental income. As a result, from the date of the beginning of construction until the assessment date, the apartment complex did not suffer a loss of income generating ability. Rather, its income generating ability remained static. Therefore, the vacancy of the apartment complex was not evidence of the apartment complex suffering a loss of value.
as statutes). Although it is possible to dream up factual situations where buildings
could become obsolete before they are built, under Pedcor's view, a large majority of
buildings under construction would be obsolete before they are built, and this
obsolescence would then magically disappear once they are finished. If the State
Board had intended this result when it adopted its regulations, it would have said so in
much clearer terms.
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