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Mutual of America Life Insurance Co. v. Tax Commission

December 17, 2009

IN RE MUTUAL OF AMERICA LIFE INSURANCE COMPANY, PETITIONER-APPELLANT,
v.
THE TAX COMMISSION, ET AL., RESPONDENTS-RESPONDENTS.



Order and judgment, Supreme Court, New York County (Leland G. DeGrasse, J.), entered on or about February 19, 2008 which, insofar as appealed from, reduced the assessed valuation of petitioner's property for the tax year 1996-1997 to $62,409,542 and confirmed the assessed valuations for the tax years 1997-1998 through 2001-2002, unanimously modified, on the law, to the extent that the trial court's findings of assessed value of the subject building for the years at issue is subject to correction, on remand, by the substitution of actual rent where available and the deduction of escalation income, and otherwise affirmed, without costs.

Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431.

This opinion is uncorrected and subject to revision before publication in the Official Reports.

Mazzarelli, J.P., Andrias, Nardelli, Catterson, JJ.

211452/02

In these consolidated tax certiorari special proceedings, for tax years 1996-97 through 2003-04, the petitioner, Mutual of America Life Insurance Company (hereinafter referred to as "Mutual"), owner of a building at 320 Park Avenue, Manhattan, challenges the assessed valuation of the property by The Tax Commission and The Commissioner of Finance of The City of New York (hereinafter referred to as the "City"). On appeal, Mutual asserts, inter alia, that the trial court overvalued the property by disallowing an annual capital expenditure deduction for leasing costs on owner-occupied space. Because there is no legal authority directly on point, and neither party cites to any section of the tax code to support its arguments, this is a case of first impression on the issue of whether such leasing costs can be taken as a below-the-line deduction*fn1 in the valuation of an investment property for tax purposes. We agree with the trial court that they may not be so deducted except where owner-occupied space becomes a de facto vacancy and the deductions are subject to proof.

The undisputed facts of this case are as follows: Mutual acquired the 34-story commercial office building at Park Avenue and 51st Street in 1992. Mutual refitted the building for use as its company headquarters in 1994-1995. The building offered approximately 675,000 square feet of rentable office space, as well as retail space on the ground floor and storage space in the below-grade levels. Of the rentable office space, Mutual occupied about 40 percent, that is 263,652 square feet (hereinafter referred to as "owner-occupied" space). The balance of rentable space was available to outside tenants. In the first tax year at issue, 1996-1997, about half of this space (30 percent) remained vacant. By the second tax year at issue, 1997-1998, approximately only 5 percent of the office space was still vacant. For the next three years the office space available to outside tenants was fully rented.

In 1996, Mutual sought an administrative correction of the building's assessed value on which the property tax was based. Mutual failed to get a correction, paid the property tax and timely commenced a special proceeding against the City to challenge the assessment pursuant to RPTL 702, 706(2) and New York City Charter §§ 163(f), 166. Mutual thereafter brought similar proceedings for the next seven tax years. Unable to reach a settlement, the eight cases were jointly tried in September 2006. At trial, each party submitted an expert's written report containing eight appraisals. Based on its expert's conclusions, Mutual withdrew its challenge to the last two tax years and thus the trial was limited to the first six tax years 1996-1997 through 2001-2002.

Both Mutual's appraiser (Jerome Haimes) and the City's appraiser (Terrence Tener) used the income capitalization approach to valuation, and both testified as experts at trial. Both experts valued the building as of the taxable status date of each year (January 5) pursuant to New York City Charter § 1507. Each applied a 45 percent equalization rate, appropriate for tax class four buildings in New York City, to produce a "fractional assessment" as required by state law pursuant to RPTL 305, 720(3), 1802(1).

The record reflects that the accepted income capitalization approach used by both experts results in an assessment of the building as an investment, with the building's income stream representing the return on investment. In this case, both parties used the same method for determining income stream (hereinafter referred to as "net operating income") as follows: by adding the actual annual gross rental income from all leased space (based on the rates and terms as reflected in lease contracts) to a hypothetical amount of gross rental income from any unleased space (based on the market rent at the time and estimated lease terms). The resultant annual gross potential income for each year was then reduced by deducting a vacancy and collection loss (calculated as an estimate based on market conditions and expressed as a percentage of the annual gross potential income). Also deducted were the annual operating expenses such as cost of utilities, maintenance, insurance, security and ongoing leasing costs. The latter costs were understood by both experts to be those annual costs budgeted for in anticipation of a future, steady turnover of tenants. Mutual characterized these -- and the City did not disagree -- as expenses which are "anticipated and amortized anticipating the large outlay to be made when a current tenant's lease ends and a replacement tenant must be found."

Further, both expert appraisers applied the same complex formula in calculating ongoing leasing costs to the total square footage of rentable space in the building, that is, to both leased and unleased space. The formula involves factoring in a lease renewal probability of 70 percent to reflect that not every tenant would vacate at the end of a lease; the length of an average lease (Mutual's expert used 13 years; the City's appraiser used 10 years); tenant concessions expressed as a dollar per square foot amount as well as leasing commissions expressed as a percentage of the annual gross income.

Tenant concessions sometimes characterized as "work letter items" were agreed to be improvements and renovations made to prepare the space for a particular tenant as a result of a lease or tenant/landlord agreement. The concessions also included lost rent between leases and free rent offered as inducement. Leasing commissions were simply broker and co-broker commissions associated with renewals and new leases.

As a result, both expert appraisers arrived within the same range of expenses associated with ongoing leasing costs, and thus at similar values for the net operating income of the building.*fn2 Both appraisers then utilized an estimated annual rate of return in order to arrive at the capitalized value of the building. For 1996-1997, Mutual's appraiser used a rate of 14.7 percent while the City's expert used a rate of 12.64 percent to reach capitalized values of $156,268,033 and $178,293,118 respectively. Finally, the assessed value could be estimated pursuant to RPTL 305, 720(3) by applying an agreed-upon equalization rate, in this case 45 percent, to the capitalized value which is also generally considered to be the market value of the property.

Both expert appraisers agreed, however, that occasionally an intermediate step is required before establishing the market value of a property when a one-time, non-recurring expense needs to be deducted as a below-the-line capital expenditure from the capitalized value. Testimony at trial established that this can be the cost of construction in rendering vacant raw space habitable by erecting drywall, installing duct work and ceilings and floors. In situations where the space is already habitable, it is the cost of tenant improvements and leasing commissions associated with an initial occupancy (hereinafter referred to as "lease-up" costs) of habitable, retrofitted space. Both appraisers in this case agreed that annual recurring on-going leasing costs do not account for the same expense as initial one-time leasing costs; that because initial costs are applied to space which does not involve a renewal but an entirely new tenant, a full and comprehensive leasing package is usually required; and, that a full leasing package on an initial occupancy would cost two to three times the expected annual rent for the space. Ongoing leasing costs were viewed as being lower than costs associated with preparing space for an initial occupancy because renewal tenants require significantly lower, or even no, work letter items such as painting or carpet replacement.

In this case, the City conceded that lease-up costs should be deducted from the capitalized value of the property for 1996-1997 for the 30 percent of rentable space that was vacant in the building in that tax year. The City's appraiser allowed for almost $23 million as a lease-up cost, and ...


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