The Comparable Sales Method
The comparable sales method is the best approach to valuing buildings, the US Tax Court said.
The court reconsidered the value of the facade on an historic building in New Orleans that houses the Ritz-Carlton hotel. A real estate partnership bought the building in 1995 and then bought the adjacent building two years later. It paid a total of $11 million for both. In 1997, it donated the façade of the building housing the Ritz-Carlton to a local nonprofit group interested in preserving the appearance of buildings in the downtown historic district. The building was built between 1907 and 1909.
The partnership claimed the façade was worth $7.445 million and claimed a charitable contribution deduction. The IRS cut the deduction to $1.15 million on audit and assessed a 40% penalty for a “gross valuation misstatement.”
The partnership basically lost in the US Tax Court in 2008 (the court set the value of the façade at $1.8 million), but the partnership then persuaded a US appeals court to send the case back to the Tax Court with instructions to reconsider. Upon reconsideration, the Tax Court made a minor adjustment in the value but otherwise stuck to its original decision.
There are three methods to arrive at value: the reproduction cost method, where the question is how much the façade would cost to reproduce, the income method, which looks at the present value of what someone could earn over time from owning the property, and the comparable sales method, which looks at the prices at which similar assets have been sold.
The court said the reproduction cost approach makes no sense when valuing historic properties, unless someone can show that it would make business sense to replicate the original façade were the building to burn down, since the cost to reproduce an ancient structure using materials and workmanship that are no longer available bears little relation to the economic value today. It said the income approach is too prone to error and to wide swings in value given the large number of assumptions that must be made and, while it is not hostile to the income method, the method is “not favored” if comparable sales data is available.
Turning to the comparable sales method, the court said it would look only at local comparables, given how important location is to valuing particular buildings. Properties are valued based on their highest and best use. A significant part of the opinion is a discussion about what that use is.
The case is Whitehouse Hotel Limited Partnership v. Commissioner. The court released its decision in late October.
by Keith Martin