A review of replacement costs can help fight inflated personal property tax assessments

The importance of understanding the true value of your personal property inventory

Many businesses may find their 2023 and 2024 are higher than expected. Rising inflation has driven the costs of materials substantially higher over the past several quarters. As a result, the index factors used by assessors to value personal property have almost doubled from the previous year. While the assessed values of personal property typically fall rapidly as equipment depreciates, these higher factors will offset a significant amount of that depreciation.

To combat these increases, businesses may want to consider reviewing the replacement costs of their personal property inventory. In instances where replacement costs are less than the values indicated by the assessment factors, there is an opportunity for substantial reductions in personal property tax liability.

Inflation is driving increases to 2023 personal property tax assessments

Assessed values for personal property are determined using the cost approach. This appraisal method is based on the principle of substitution - a purchaser will not pay more for property than the cost of a replacement of equal utility. To apply the cost approach, the assessor reviews businesses’ annual returns, which list the original costs of property and the date acquired. A Trend Factor is applied to the original cost to reflect values as of the reference date (typically January 1 of the taxation year) and then depreciation is calculated based on the age of the property and its expected useful life.

The Trend Factors are determined in a manner similar to the consumer price index, based on the overall increase in materials costs. Not all materials or products have increased in value at the same rate, however – so applying the trend factor to the original cost of equipment may result in a value that is higher than the cost to replace that equipment.

Figure 1 - Trend factors for California personal property 2020-2012

Trend factors are applied to original costs to reflect reproduction cost as of the date of valuation.

Assessments for depreciated assets may be higher than the cost of replacing the equipment today

While the chart above comes from California, the factors used in most states will be similar. Based on the 2023 factors, equipment purchased in 2021 will be assessed at 15% more than you paid for it. Equipment bought in 2018 will have an assessed cost that is 30% higher than its acquisition price. Although these values will be adjusted to reflect depreciation, in some cases the depreciated assessed value will be more than what it would cost to buy the same equipment today. In this case, determining the replacement cost of the equipment can result in a substantial reduction in personal property tax.

To correctly apply the cost approach, the value of a property should be based on its replacement cost, rather than its reproduction cost.

• Reproduction cost – what an exact replica of the product costs today

• Replacement cost – the cost of a current product with the same utility as the historical product

Imagine if televisions were valued using the trend factors, and you acquired a new 55-inch OLED TV in 2013, when it was priced at $12,000. Applying the 40% “Trend Factor” to the 2013 purchase price results in a “reproduction cost new” of $16,800. A better OLED TV with more features is currently available for less than $1,300 today, which means that the replacement cost of that 2013 TV is less than $1,300, and a fraction of the reproduction cost.

Electronics technology improves at an astonishing rate, and so the factors listed don’t apply to televisions for this reason. The above example is provided to illustrate the principle. Not only do some products increase in cost at different rates, but as technology improves, a product available now may have more features and greater capacity than the product that was available in the past. When this is the case, the replacement cost should also be adjusted to reflect the higher capacity of the current product.

Appealing business personal property assessments can result in substantial tax savings

For example, consider a conveyor purchased in 2018 for $40 million with the capacity to move 3,000 widgets per day. A modern replacement conveyor can be purchased in 2023 for $50 million and with a capacity to move 9,000 widgets per day. Based on the assessor’s trend factors, the reproduction cost of the 2018 conveyor will be $52 million (2018 cost x 1.30 trend factor). As the replacement property has three times the capacity of the 2018 conveyor, the replacement value must be adjusted to reflect this deficiency. After adjusting the replacement property for its excess capacity, the replacement cost of the conveyor is $25.9 million - less than half the reproduction cost calculated by the assessor.

While the above hypothetical is extreme, it is not far removed from actual experience. A review of replacement costs can result in 20-30% reductions in the value of business personal property. If the personal property of a distribution center has a total assessed value of say, $200 million, a 20% reduction in that assessed value could provide tax savings of $400,000 - $800,000, depending on your tax jurisdiction.