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California Seeks to Clarify Standards of Review for Hotel Property Tax Assessment Appeals

Hotels are one of the most misunderstood properties when valued by local assessors for property tax purposes.  A hotel’s enterprise activity is comprised of tangible property, in the form of real estate and personal property, and intangible property, which includes but is not limited to the hotel flag, other intellectual property, management skill, reservation systems and a trained workforce.  The failure of assessors to properly remove the value of non-taxable intangible property when valuing a hotel’s taxable property has been the topic of four recent California appellate court decisions that examine the standards review under such circumstances. 

Pursuant to California law, when a proper valuation method is used to value taxable property, factual findings and determinations of value are presumed to be correct and will be sustained on appeal if supported by substantial evidence.  The “substantial evidence” standard is an extremely high standard to overcome for a taxpayer seeking judicial review of an adverse administrative decision because it must be shown that the decision is so arbitrary as to constitute a deprivation of property without due process of law.  If the taxpayer attacks the validity of the valuation method itself, however, the issue becomes a question of law subject to de novo trial court review. 

In three of four recent appellate court decisions, which are discussed in chronological order below, the taxpayer appealed from a trial court decision that found the assessor’s method for valuing the real estate component of a going-concern enterprise was valid and, thus, the assessment was presumed correct and subject to the substantial evidence standard.  The four cases and their interrelationship are summarized below.  

Case No. 1: EHP I

In EHP Glendale, LLC, et al. v. County of Los Angeles, 193 Cal. App. 4th 262 (2d District 2011) (“EHP I”) the County appealed from a trial court summary judgment order finding that the valuation methodology used by the Assessor, and accepted by the Los Angeles County Assessment Appeals Board (the “Board”), to value a hotel property was contrary to California law.  In particular, the trial court found the assessor’s valuation methodology legally flawed because it failed to exclude the hotel’s intangible assets from the real property tax assessment.  EHP I, 193 Cal. App. 4th at 268.

The Court of Appeal reversed on grounds that summary judgment was inappropriate when less than the entire Board administrative record was before the trial court when it entered its summary judgment order.  Id. at 271-73.  However, the Court of Appeal nevertheless addressed the issue upon which the trial court decision was based, i.e., whether the Assessor’s hotel income approach valuation was legally flawed.  The Court of Appeal disagreed with the trial court’s finding that the appropriateness of the assessor’s value methodology presented an issue of law.  Id. at 273-74.  According to the Court of Appeal, the assessor’s income approach method was valid and presented only a question of fact as to its application.  See id at 276.  Invoking the presumption of correctness, the court found there was substantial evidence to support the Board’s decision and remanded the case to the trial court for trial.  Id.

Case No. 2: Elk Hills

In 2013 the California Supreme Court addressed the same issues addressed by the Court of Appeal in EHP I; i.e., the appropriate method to valuing the real estate component of a going-concern enterprise and the appropriate standard of review of an assessment appeal.  Elk Hills Power, LLC v. Board of Equalization, 57 Cal. 4th 593 (2013) (“Elk Hills”).  In that case, Elk Hills was required to purchase emission reduction credits (“ERCs”) from a local pollution control district in order to build and operate a new power plant.  Id. at 604.  Elk Hills appealed the real property tax assessment extended against the new power plant by the California State Board of Equalization (the “Equalization Board”).  Elk Hills claimed the Equalization Board’s assessment included the value of the ERCs, stipulated by the parties to be non-taxable intangible property.  Id. at 605.  The trial court entered summary judgment in favor of the Equalization Board, finding the ERCs to be intangible attributes of real property and thus subject to assessment and tax under California law.  Id.  The Court of Appeal affirmed the finding that the intangible property was taxable, but on different grounds.  Id.  The Court of Appeal found that because the ERCs were necessary to the use of the power plant, their presence was properly assumed in the Board’s assessment. Id.  The Supreme Court granted Elk Hills’ petition for review and addressed the proper standard for appellate court review and the proper method for valuing the real estate component of a going-concern enterprise. 

First, the Supreme Court summarized California law that applies to the scope of review of assessment decisions.  Id. at 606.  When a proper valuation method is used to value taxable property, factual findings and value determinations are presumed to be correct and will be sustained on appeal if supported by substantial evidence.  Id.  Moreover, reversing an assessment decision presumed to be correct occurs only where the decision is so arbitrary as to constitute a deprivation of property without due process of law.  See Bret Harte Inn, Inc. v. San Francisco, 16 Cal. 3d 14, 23 (Cal. 1976).  This is a significant burden that is rarely met.  However, when a taxpayer attacks the validity of the value method itself, the issue becomes a question of law subject to de novo review.  Elk Hills, 57 Cal. 4th at 606.

The Court found that Elk Hills had challenged the validity of the Board’s valuation methodology, and in particular its inclusion of the ERCs’ value in its assessment.  Id.  Accordingly, the issue presented was not one of fact but one of law to be reviewed de novo.  Id.  The Court’s ruling on the proper standard of review constituted a significant win for Elk Hills, and all California going-concern enterprises owning taxable property, considering the almost insurmountable burden a taxpayer faces in attempting to reverse an adverse Board decision under the substantial evidence standard.

Reviewing the Court of Appeals decision de novo, the Court construed the statutory intent of two California Property Tax Code provisions that address the role of intangible assets in the assessment of taxable property.  See id. at 607-16.  In doing so the Court affirmed that intangible property is exempt from property tax and that its value cannot be included in the value of taxable property.  Id. at 615.  However, the presence of intangible property necessary to the productive use of a going-concern enterprise can be assumed in determining the value of taxable property.  Id.  Finally, the Court found that the assessor must remove the value of intangible assets that are a component part of a going-concern enterprise prior to issuing an assessment for the taxable components of that enterprise.  See id. at 621.  Elk Hills does not cite EHP I and its conflicting decision.  However, EHP Glendale, LLC, et al. v. County of Los Angeles, 219 Cal. App. 4th 1015 (2d District 2013) (“EHP II”), issued approximately one month after Elk Hills not only cites Elk Hills but goes to great length to distinguish it and its progeny.

Case No. 3: EHP II

The Elk Hills decision was issued on August 12, 2013.  On September 18, 2013, the Second District Court of Appeal issued its second decision in EHP II.  On remand of EHP I, a new trial court judge applied both the de novo and substantial evidence standards in ruling the assessor’s and Board’s income approach methodology was valid as a matter of law and that substantial evidence supported the Board’s decision.  EHP II, 219 Cal. App. 4th at 1025-26.

The hotel owner once again appealed claiming that the value method applied was flawed as a matter of law.  The EHP IIcourt affirmed, finding its prior decision in EHP I constituted the law of the case, which it was bound by law to follow unless the law was altered by an intervening decision by a higher tribunal.  Id. at 1026-27.  According to the EHP II court, the Supreme Court’s decision in Elk Hills did not alter the law it applied in EHP I.  The court attempted to distinguish Elk Hills by trying to differentiate the issues presented in the two cases.  Id. at 1028.  Notwithstanding the taxpayer claim in both cases that the assessor and Board applied an invalid value method, the court reasoned that in Elk Hills the issue was one of statutory interpretation, “which is reviewed de novo as a question of methodology,” whereas in EHP II the issue was whether adequate value for intangible assets was removed from the hotel assessment.  See id.

Notwithstanding that the hotel owner had challenged the validity of the assessor’s and Board’s methodology – the precise issue about which the California Supreme Court in Elk Hills concluded should be reviewed under a de novo standard – theEHP II court framed the issue as one of fact to be reviewed under the substantial evidence standard.  Id. at 1028-29.  The issue as framed by the EHP II court appears to have ignored the ruling in Elk Hills.  Interestingly, on December 18, 2013, the California Supreme Court denied the hotel owner’s petition for review; however, in doing so it also ordered that the EHP IIdecision not be published or cited as authority.  EHP Glendale, LLC v. County of Los Angeles, 2013 Cal. LEXIS 10499 (Cal. Dec. 18, 2013).  EHP II therefore has no precedential value.

Case No. 4: SHC

Shortly thereafter, another hotel assessment appeal decision was issued by the First District Court of Appeal in SHC Half Moon Bay v. County of San Mateo, 226 Cal. App. 4th 471 (1st Dist. May 22, 2014) (“SHC”).  Similar to the taxpayer in EHP Iand II, SHC appealed its 2004 assessment to the San Mateo County Assessment Appeals Board claiming the assessment methodology was invalid because the assessment included non-taxable intangible assets.  SHC, 226 Cal. App. 4th at 475.  SHC appealed the Board’s decision which found that the assessor’s income approach properly removed the value of the hotel’s intangible assets from the real property assessment.  Relying on EHP I, the trial court affirmed the Board’s decision, finding the income approach was a valid method to determine property value and that substantial evidence supported the assessor’s valuation.  Id. at 482.  The trial court’s decision was issued before the California Supreme Court’s decision in Elk Hills.  The SHC court, relying on the previously issued Elk Hills decision, explained that California property tax law precluded the value of intangible assets from being included in the value of taxable property.  Id. 483.  However, the value of taxable property may be enhanced by assuming the presence of intangible assets.  Id.

Similar to the Supreme Court in Elk Hills, the SHC court first addressed whether the claim that the income approach methodology was invalid presented an issue of law or fact.  Id. at 486.  The SHC court acknowledged the difficulty California courts had experienced in distinguishing between a challenge to a value methodology as opposed to the application of a valid value methodology.  Id.  Consistent with Elk Hills, the court relied upon SHC’s claim that the assessor’s value methodology was legally flawed to find that the issue presented a question of law and to be reviewed under a de novostandard.  Id.

The Elk Hills and SHC opinions cite numerous California decisions that support the proposition that if the appellant taxpayer claims the value methodology is invalid, then a question of law is presented for de novo review.  Id. at 487-88.  Notwithstanding, the assessor and County of San Mateo argued EHP I was controlling and that a substantial evidence standard applied.  Id. at 488.  The SHC court distinguished EHP I, finding its ruling was limited to whether summary judgment was appropriate considering the trial court had less than the entire record before it.  Id. at 489.  The court deemed any pronouncements on the validity of the assessor’s income methodology to be dicta.  Id.  Relying heavily on Elk Hills andGTE Sprint Communications Corp. v. County of Alameda, 26 Cal. App. 4th 992 (1994), the SHC court reversed the trial court and found that the value of certain hotel intangible assets were included in the hotel’s real property valuation in violation of California law.  Id. at 492-93.

Elk Hills and SHC appear to clarify California law regarding the standard of review for assessment appeals.  Moreover, these decisions clarify assessors’ legal obligation to remove the value of intangibles from the value of going-concern enterprise taxable property.  Had the Supreme Court not ordered the Second District’s EHP II decision to not be published or cited, there would have been a conflict between the Districts on the appropriate standard in which to review an assessment appeal.  Whether the Second District will follow its decision in EHP II when next presented with the standard of review issue, or conform its opinion to Elk Hills and SHC, will be of interest to all California going-concern enterprises.  That notwithstanding, owners of going-concern enterprises that include taxable tangible property and non-taxable intangible property should be aware of the recent developments in California property tax law that may create opportunities to successfully appeal property tax assessments.

© 2019 Neal, Gerber & Eisenberg LLP.


About this Author

David S. Martin, Real Estate attorney, Neal Gerber law firm

David S. Martin is a partner in the firm’s Property Tax Group. Having commenced his career in the Property Tax Unit of the Cook County Assistant State’s Attorney’s office, he has devoted his entire career to all aspects of state and local property tax. David’s representative client base ranges from Fortune 500 companies to class plaintiffs in taxpayer class actions. His significant representations include being lead trial and appellate court attorney for City of Chicago taxpayers, which resulted in the largest property tax judgment in Illinois history. Another of David’s...

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