In North Carolina, taxing jurisdictions determine the amount of tax that must be paid on real property and business personal property based on the “true value” of that property. The taxing jurisdictions are generally counties and cities, each of which set the property tax rate to be applied to the “true values” of taxable property within their boundaries. The term “true value” is defined by N.C.G.S. Section 105-283 as market value, which is the price at which the property would be sold by a willing seller to a willing and financially able buyer if neither were under any compulsion to buy or sell and if both had reasonable knowledge of all the potential uses for the property. So, the concept of calculating taxes is simple.
- Set the tax rate.
- Determine market value of the property to be taxed.
- Apply the tax rate to the determined market value.
In practice though, the trouble starts at Step 2 when the taxing jurisdictions try to determine the market value of property. There are only three valuation methods recognized by North Carolina courts.
The Cost Approach
The cost approach determines market value by estimating the value of land (typically using the sales comparison approach), and then estimating the value of any improvements on that land (like buildings or paving) by starting with the replacement cost of each improvement and then depreciating that cost to account for physical deterioration, functional obsolescence, and economic obsolescence suffered by the improvement. The idea is that buyers in the market will not pay more for a property than it costs to build, taking into account all forms of depreciation.
The Income Capitalization Approach
The income capitalization approach determines market value by capitalizing the net operating income of a particular income producing property by an appropriate capitalization rate. The idea is that buyers of income producing properties are investors who won’t pay more for a property than they estimate they will make by owning that property over a standard ownership period. Similarly, sellers of income producing properties will not sell a property for less than they stand to make by continuing their ownership.
The Sales Comparison Approach
The sales comparison approach determines market value of a particular property by searching for sales of other properties that are reasonably comparable and adjusting their sales prices to account for any substantive differences. The idea is that buyers won’t pay more for a property than they would need to pay to buy a comparable property, and sellers won’t sell a property for less than comparable properties are selling for.
More often than not, an essential issue of any property tax appeal is which method or methods are applicable and, of the applicable methods, which one is most convincing. Stay tuned for coming posts about the strengths, shortfalls, and appropriate applications of each recognized approach.
Image by Yulasha, available for use as part of the public domain.