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A Creative Approach to Property Tax Reform

One of the issues South Dakota voters will be asked to decide this November is Constitutional Amendment D, the latest attempt to reform our property tax system. It would base the assessed value on the purchase price of a piece of property rather than the comparative values of similar properties.

If county officials had the resources to keep up with the market by assessing all property every year, assessed values would increase gradually. Instead, many properties are reassessed every few years. If neighboring properties have sold for significantly higher prices during that time, the assessed value of a property might increase dramatically. This is especially true for commercial property in an area of new development. Attempting to avoid such unpleasant surprises is the driving force behind Amendment D.

Amendment D would roll back current assessed valuations to the 2003 valuation, then cap the annual increase in those values at three percent. It’s important to note that this is a cap on your property’s assessed value, not a cap on property taxes.

Then, beginning January 1, 2007, the assessed value would be set according to the purchase price whenever a piece of property is sold. The assessed value also “may be further adjusted if there is a change in use or classification or to account for any addition, improvement, or destruction to the property.”

To illustrate, let’s take two virtually identical houses in a fast-growing area. In 2003, they were each assessed at $100,000, which we will assume to be 80% of their market value. Under Amendment D, that assessment can only increase by three percent each year. By 2017, each of them would be assessed at just over $152,000.

Now, let’s assume that property values increase at 7.5% annually, which is the historical average for Rapid City. The 2017 market value of each house would be $350,000. If one property sells, its new owner would pay taxes over twice as high as those paid by the owner of the property that had not been sold.

The bottom line is this: Amendment D will reward owners who don’t sell their property. You would enhance the value of your property to a future buyer, then, if you could transfer it without selling it.

There is a way you can do exactly that. If the property is owned, not by you, but by a separate legal entity owned by you, what you sell is your ownership of that entity. The legal ownership of the property does not change.

The best vehicle for this would be an LLC, or limited liability company. An LLC has many of the same features and protection as a corporation, as well as the pass-through features of a partnership. If each piece of real estate is owned by a separate LLC, you could sell your shares in that LLC to someone who wanted that property.

The disadvantages of this plan would be the costs to set up LLCs, plus the need to file separate tax returns for each one. The advantage would not be lower property taxes for you, but lower property taxes for a future buyer. There is a real possibility that this would enhance the value of your property whenever you decided to sell it.

In the example above, let’s assume the taxes on the home that was sold increased by $3000 a year. If that property had been in an LLC so the taxes stayed the same, how much of a premium would a buyer pay to save $3,000 a year? My guess is somewhere between $3,000 and $30,000. That’s a significant gain for the seller.

In next week’s column, I’ll discuss this strategy in more detail.

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