Hospitality owners and operators paying exorbitant property tax bills should consider whether their valuation from the local assessor presents a true valuation of taxable property or instead values a larger, multifaceted business enterprise that encompasses non-taxable income sources.
As any owner or operator can attest, hotels and resorts produce a multitude of income streams. The obvious and most significant sources are short- and long-term room rentals and food and beverage sales. But nearly all operations conducted on hotel and resort properties, both large and small, add to the total revenues those properties generate.
These revenues are not lost on taxing authorities. Local assessors and assessing districts usually rely on these revenues to value hotel and resort properties and, in turn, establish the amount of property taxes owed.
For decades, hotel owners and operators have had little alternative but to pay property taxes on assessments calculated from the revenues their properties produce. While taxpayers are allowed to deduct operating expenses from revenues and only report net income, that provides little solace in the face of massive tax bills. From the operator’s perspective, hospitality property taxes often appear to be a secondary form of income taxation, having little to do with the valuation of taxable property.
In recent cases, appellate courts have adopted a broader view, ruling that assessors must deduct most types of operational income when calculating a hospitality property’s taxable value.
Deducting Operating Expenses Alone Does Not Produce Taxable Values
The conundrum hospitality properties face is this: The net incomes taxing authorities use to make property tax assessments do not exclude all of a hotel’s or resort’s business enterprise value. Even after removing departmental operating expenses, those income figures retain the portion of revenue that every operation in a hospitality property contributes to the bottom line.
Tax assessors contend that by deducting the expenses associated with every one of a hospitality property’s operating departments, the non-taxable business enterprise value relating to that department has been excluded from taxation. But that is not the case. Deducting the operating expense of a hotel/resort department only considers the direct expense of that unit’s operation. The deduction is sometimes called the “return of” the expense. It does not account for and remove the profit, also known as the “return on” the operational outlay, which is also nontaxable in property taxation.
Owners/Managers Only Want Profitable Operating Departments
There is always a “return on” component in an ongoing operation, or else the owner or manager would discontinue the activity as lacking justification.
For example, suppose a hotel wishes to offer banquet and meeting services to its clients. The owner/operator determines the amount of revenue such an operation will produce, calculates the expenses of providing banquet/meeting services (the “return of”), and subtracts those expenses from revenues to see if the operation will return a profit (the “return on”).
The decision to offer banquet/meeting services turns on whether there is any profit (“return on”) in doing so. If there is no profit, the hotel will not provide the service.
Assessors Ignore “Return On”
If hospitality property owners only provide services that are profitable, then the net income from those services necessarily includes a “return on” or associated profit that does not contribute to taxable real property value. However, as discussed, tax assessors rely on net income in making their assessments.
The problem is that the assessor values the property using net income that includes more than just the direct operating expense for each service department, which is typically deducted. The net income also includes the profit associated with that department. Profit must be present; otherwise, the owner/operator would not provide the service.
The assessor’s failure to recognize and deduct profit from each department’s operations leads to the taxpayer’s complaint that the property tax assessment is also an income tax in disguise. That’s because it attributes taxable property value to the “return on” or profit from the department that is part of the hotel’s or resort’s operations.
“Return On” for All Property Departments Should Be Excluded from Tax Assessment
This line of reasoning applies to all operating departments in a hotel or resort. Clearly, the assessor must exclude profit or “return on” received by a hospitality property’s food and beverage operation. Exclusions should also be made for the profit earned by a property’s spa, golf and other on-site retail operations.
The taxpayer and assessor should even consider small revenue departments (often simply referred to as “other operating departments”), such as parking and valet, laundry, movie rental and high-speed internet access services, as well as vending machines. While the revenues these services generate individually are minimal, when combined, they may be significant.
Remember that such services are not provided unless they will produce a profit. Some owners and operators are surprised to learn that even services provided off site, such as dry cleaning, can still merit a “return on” deduction in calculating taxable property value.
Demand “Return On” Deductions when Making Assessments
Recent appellate court decisions support “return on” deductions in property tax assessments. One of the leading cases is SHR St. Francis LLC vs. City and County of San Francisco, decided in 2023, in which the California Court of Appeal instructed the county assessor to remove values for “return on” in-room movie services and off-site guest laundry services provided by Westin’s St. Francis Hotel, located in San Francisco’s Union Square. The appellate court found that a portion of the income streams generated by those services had to be removed from the St. Francis Hotel’s net income in making property tax assessments.
Hotel and resort operators would do well to report to the local property tax assessor “return on” for all operating departments at their property and to request that the profits earned by those departments be excluded from consideration in assessing their properties. And, if the taxing authorities fail to deduct operating profits in making their assessments, taxpayers should pursue administrative or judicial appeals.
Cris O’Neall is an attorney shareholder at Greenberg Traurig, LLP, the California member of American Property Tax Counsel, the national affiliation of property tax attorneys.