Top tips for accounting firms: How to determine property taxability

As an accountant, you want to help your clients pay only the tax they owe — on or before when payments are due. Property tax overpayment or penalties can affect profitability and EBITDA (earnings before interest, taxes, depreciation, and amortization).

Accounting service providers can add property tax compliance to their practice to attract new clients. Although this is a complex area, automation can help bring speed and accuracy to the process. 

A critical part of providing property tax compliance services is understanding what property is taxable and what property isn’t subject to property taxation. But each jurisdiction’s property tax rules are different.

To help you determine property taxability, we’ve summed up these key concepts and questions to consider:

• What is the difference between real property and personal property?
• How is the three-prong test used to classify permanent fixtures? 
• What factors influence property values?
• How should an accounting firm identify property tax exemptions, thresholds, and ghost assets?

Understanding the difference between real property and personal property should be your first step toward helping your clients pay exactly the tax they owe. 

Most of the time the difference is obvious. Real property, also called real estate, includes land and anything permanently attached. Office buildings, stores, warehouses, parking lots, and fences are examples of real property. 

Personal property is moveable. Furniture, computers, and manufacturing equipment are common examples.

Here’s where things get tricky. Sometimes personal property can become part of real property. When this happens, it becomes a fixture. Permanent fixtures are part of the real estate value and are taxed differently than personal property.

Many states apply what’s called the three-prong test when determining whether property should be classified as a permanent fixture, while other states apply some variation of this criteria. Assessors typically consider these three factors:

• Annexation/attachment: How the property is connected to the real estate and whether removing it would cause damage.
  Shelving installed in a grocery store and bolted to the walls and floors might be considered real estate, for example. However, freestanding display racks in the same store are personal property because they can easily be moved. 

• Adaptation: How the property is used.  
  A custom-designed conveyor belt in a factory may be considered real estate. A stand-alone assembly line cart is personal property. 

• Intent: Whether the property is intended to be permanently attached to the real estate and whether the best use of the real estate changes. 

Large servers and cooling systems installed at a data center may be considered real estate. Equipment racks that can be relocated may be considered personal property.

Some states apply different criteria, so your firm shouldn’t assume the rules in one jurisdiction are the same in another. 

Hawaii considers whether the fixture’s use is necessary to the utility of building structures and improvements. If it is, then it becomes part of the value of the real estate. However, all personal property is exempt from tax in Hawaii.

Iowa is another state that exempts personal property from taxation. When considering whether a fixture is permanent, Iowa looks at whether the item would typically be removed when the real estate is vacated.

Recognizing factors that impact the value of your clients’ property is your next step.

Real property typically appreciates in value. However, lingering effects of the pandemic mean some commercial properties still remain vacant and their fair market values have declined. 

Personal property, on the other hand, typically depreciates in value with age. Other factors can make the property worth significantly less than normal wear and tear alone. For example, if an item isn’t functioning as designed or market conditions have made its use less relevant, then functional obsolescence and economic obsolescence, respectively, come into play.

Knowing what your clients’ property is worth allows you to advise whether they should appeal an assessor’s valuation.

Another way you can help your clients is to make sure they don’t pay tax on property that’s not taxable. Unfortunately, legislation is always changing so you need a reliable way to track the latest rules and regulations across all the jurisdictions where your clients have property. An advanced property tax compliance solution with a built-in repository of property tax information can help.

Eight states exempt all personal property from taxation: Delaware, Hawaii, Illinois, Iowa, New York, Ohio, Pennsylvania, and, most recently, Wisconsin. Five states exempt personal property for most businesses: Minnesota, New Hampshire, New Jersey, North Dakota, and South Dakota.

Some counties create minimum thresholds under which businesses that have assets or annual revenues below a certain amount aren’t required to file property tax returns. Thresholds can also apply to specific properties listed on a return. For example, you might ask yourself whether it makes sense to lump all of a client’s computers together or break them out separately to fall below the threshold.

Some jurisdictions exempt business inventory or vehicles. In other jurisdictions, vehicles and inventory are subject to personal property tax. 

Intangible assets may be exempt; these can sometimes include canned computer software, software embedded in robots used for manufacturing, and digital assets.

Ghost assets are items that are reflected on the books but may no longer be owned and shouldn’t be reported. Broken laptops, shopping carts that are missing wheels, malfunctioning security cameras, and defunct conveyor belts are examples. Another common mistake businesses make is to continue to report installation costs associated with software or equipment bought years ago, so they’re still paying tax on those services.

Using a spreadsheet to try to spot ghost assets and track exemptions is cumbersome. With an advanced property tax compliance solution, you simply check a box to indicate the property is nonreportable or nontaxable. You can then generate a report to show your clients a list of nontaxable properties, so they have a clear picture of how you’re saving them money.

Property taxability is complex, but automation makes it simpler to manage property tax compliance for your clients. 

Avalara Property Tax for Accountants helps you protect your clients from potential overpayments and penalties. Manage clients’ real and personal property tax in one secure hub. Taxability rules for jurisdictions throughout the United States are built into the solution, along with tools that improve accuracy and efficiency during each stage of the property tax compliance cycle. 

Contact us to learn more about how Avalara can help you provide maximum value to your clients while minimizing manual, time-consuming processes.