Tenant Bankruptcies Can Lead to Tax Breaks

Recently, many retailers who represent the mainstays of malls and shopping centers across the country have filed for bankruptcy protection. Examples include: Sharper Image, Linens & Things, Steve & Barry’s, Mrs. Fields, Bombay Company, Hollywood Video and Mervyns. Then, too, The Gap, Charming Shoppes and other retailers have announced plans to close substantial numbers of stores in the wake of weak sales. The prospect of these retail outlets going dark presents an array of challenges to property owners, who already share in retailers’ woes by way of falling percentage rents.

These challenges include the very material hit landlords take to their bottom lines as a result of expending resources on tenants in default before they petition for bankruptcy, keeping tenants current on obligations post-petition and maneuvering through the maze of court orders, notices, and deadlines. Nevertheless, property owners who carefully quantify their economic losses associated with tenant bankruptcies may preserve a portion of their investments by appealing their property tax assessments.

Possible Claims When Appealing

In bankruptcy situations, various claims are available to help a taxpayer decrease assessed values and property tax bills. For example, using the income approach to value, a taxpayer can prove a diminished prospective income stream from leasing retail property to support a lower assessment. Likewise, a taxpayer can support a lower assessment under the sales comparison approach to value by utilizing in the analysis comparable sales of properties where tenants have filed bankruptcy, or supporting adjustments to comparable sales to account for the effects from bankruptcy.

However, because of the unique conditions faced by a property owner with tenants in bankruptcy, the best case for a reduced assessment might be made by claiming economic obsolescence.

How to Claim Economic Obsolescence

Economic obsolescence occurs where conditions extraneous to the property itself cause actual losses in the property’s value. Common examples of such conditions include population changes, economic trends, and government restrictions. In claiming economic obsolescence before an administrative review board or court, a taxpayer typically is required to prove an incurable loss in value has occurred and to explain how specific conditions caused that loss.

The Bankruptcy Code actually creates conditions for a landlord that may cause such economic loss. For instance, a tenant’s bankruptcy petition initiates an automatic stay during which the landlord cannot pursue collections of rents past-due or eviction proceedings. The law then provides the debtor in possession or trustee 120 days to decide whether to assume or reject a real property lease, and the tenant also may obtain a 90-day extension on its decision.

If the tenant decides to assume the lease, months could pass before the landlord recovers any past due rent. Moreover, the tenant could assign the lease to another party. Even though the law says that the assignee must be comparable to the former tenant, in practice, it does not always work out that way. Should the tenant reject the lease, other issues arise concerning the tenant vacating the property, such as surrendering personal property subject to claims of other creditors and leaving behind signs and fixtures.

A landlord cannot avoid some level of loss when navigating the intricacies of a tenant’s bankruptcy proceedings and working with the tenant or assignee to keep it in business. Losses become especially evident where tenants reject leases and outlets go dark. A property’s value diminishes significantly in periods where filling vacant space presents an enormous challenge and recovering losses caused by tenant’s bankruptcy filings are virtually impossible. The diminution in value in most states should translate into a reduced assessed value.

Savvy mall and shopping center owners claim economic obsolescence to support property tax reductions in bankruptcy cases. Historically, a claim of economic obsolescence has not been a slam-dunk before courts and review boards, but with careful accounting and a clear demonstration of the link between losses and tenant bankruptcy, owners can achieve tax reductions.

Stephen H. Paul is a partner in the Indianapolis law firm of Baker & Daniels LLP, and the Indiana member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reach at: [email protected].

The opinions expressed in this article are the author’s own.