Value of Intangible Assets That Make a Direct Contribution to the Going Concern Value of a Business Must be Deducted from Property Valuation, as the Assessor Did Correctly

After the sale of an upscale city hotel, a county assessor reassessed the property.  The new owner challenged the assessment, claiming it improperly included the value of nontaxable intangible assets.  The county assessment appeals board denied the appeal.  A trial court reversed the board decision, only to be reversed itself by the court of appeal, which ordered the case to be heard again in trial court.  The second trial court found in favor of the board decision.  On appeal a second time, the appellate court upheld the trial court decision, finding that substantial evidence supported the board finding that the assessor correctly excluded the value of nontaxable intangible assets from the assessment.  (EHP Glendale, LLC v. County of Los Angeles (2013) 219 Cal.App.4th 1015).


In 2005, Hilton Hotels Corporation (“Hilton”) sold the Glendale Hilton to Eagle Hospitality Properties Trust, Inc. (“Eagle”).  Eagle paid $79.8 million, which included the real property, hotel furniture, fixtures, equipment, and certain intangible assets and rights.  Among the intangible assets were a franchise agreement with Hilton and a management contract under which Hilton would manage the hotel for two years.

The Los Angeles County assessor reassessed the property at $79.8 million.  Eagle appealed the assessment to the Los Angeles County Assessment Appeals Board (“Board”), arguing that the assessor had applied an invalid appraisal methodology and that the assessment improperly included the value of nontaxable intangible assets.  The Board upheld the assessor's property valuation.

Eagle appealed the Board decision by bringing a lawsuit against Los Angeles County (“County”) seeking a property tax refund of $187,000.  A trial court ruled in favor of Eagle, granting its motion for summary judgment and finding that the assessor's methodology failed to fully exclude nontaxable intangible assets from the assessment.  On appeal, the Second District Court of Appeal reversed the trial court decision, holding that the income approach applied by the assessor was a valid methodology for determining full cash value and that the administrative record presented was too incomplete to properly review the case.  The appellate court also found that the trial court erred in granting the summary judgment motion because even the fragmentary record that was presented raised questions of fact that deserved a fuller airing than was available on summary judgment.

The appellate court additionally explained that the trial court had erred in weighing the credibility of the valuation expert’s testimony.  Instead, the issue of witness credibility was a factual matter to be decided by the Board, and the trial court was restricted to determining whether substantial evidence supported the Board's decision.  The appellate court remanded the case back to the trial court level for consideration based on a complete administrative record.

On remand, a different trial court judge ruled against Eagle, finding that the assessor’s valuation and the Board’s decision were supported by the evidence.  Eagle appealed a second time.


The Second District Court of Appeal affirmed the trial court decision this time, affirming the assessment.  The appellate court noted at the outset that on this second appeal, it was limited to reviewing whether the Board's decision was supported by substantial evidence.  The appellate court found that substantial evidence supported the Board's decision. 

The court explained that California property taxes are assessed based on “fair market value,” the price a property would fetch on the open market with both the buyer and seller understanding the purposes for which the property could be used.  The fair market value is presumed to be the purchase price of the property, unless “a preponderance of the evidence” indicates otherwise.  Assessors apply three methods of determining fair market value: the market data method, the income method and the cost method.  The income method applied by the assessor in this case involves capitalizing the income attributable to the property, then subtracting an amount based on the risk of that income being less than expected.

In applying any valuation method, intangible assets are excluded because they are generally not subject to direct taxation under California law.  At the same time, the presence of intangible assets or rights may be assumed in the property valuation to the extent that those intangible assets or rights are “necessary to put the taxable property to beneficial or productive use.”  Because the presence of intangible assets may be assumed in reaching an overall fair market value for a property, but the intangible assets themselves may not be directly taxed, assessors must remove the value of intangible assets “from a unit's taxable base value, so that the intangibles are not directly taxed.”

The appellate court stated that because it had already decided the assessor used a valid methodology, the issue in this case was “whether the assessor subtracted an adequate value for intangible assets from the income stream of the hotel.”  The court noted that the purchase price of a property is assumed to be its fair market value, and the Board received evidence that the hotel’s price was based only on the taxable real property and hotel furniture, fixtures and equipment, not intangible assets such as the value of the franchise and management agreements.

The appellate court rejected Eagle’s argument that the assessor should have deducted from the purchase price the value of the hotel's various service centers, such as the restaurants, room telephone and telecommunications services, business center, vending machines, health club, guest laundry, and parking facilities.  Eagle contended these service centers were independent businesses.  The court found that it was reasonable for the assessor to consider the presence of the service centers as necessary parts of a full-service, first-class hotel.  The court stated that to adopt Eagle’s argument to deduct the service centers from the purchase price would alter the character of the hotel as a full-service venue.  This “would have violated the requirement that the hotel be assessed at its full market value, including by assuming the presence of intangible assets.”

The appellate court held that substantial evidence also supported the Board's conclusion that the assessor correctly subtracted the value of the hotel’s intangible assets when he applied the income approach, “by subtracting the expenses of intangible assets from the income stream to be capitalized.”  The court dismissed Eagle’s argument that the assessor violated property tax Rule 8(e), which requires that the income approach exclude enough income “to provide a return on working capital and other nontaxable operating assets and to compensate unpaid or underpaid management.”  The court pointed out that the hotel’s owner prior to Hilton had produced higher net incomes than Hilton had, which supported an inference that no additional deduction was justified “for a return on the intangible assets such as the franchise and management agreements because they did not carry a value beyond the market rate.” 

The court noted that this approach ran counter to guidance published in the State Board of Equalization’s Assessors’ Handbook, but the court sided with the County’s argument that the guidance in the Handbook was based on the “flawed assumption” that a management expense always results “in a positive ‘return on’ that expense that should be recognized in addition to the amount of the expense itself and charged against revenue.”  The court also noted that the Handbook is merely guidance, not a regulation, and does not carry the force of law.

Finally, the appellate court discussed the recent property tax case Elk Hills Power, LLC v. Board of Equalization (2013) 57 Cal.4th 593, which found that under the income stream method of valuation “not all intangible rights have a quantifiable fair market value that must be deducted.”  Elk Hills explained that intangible rights that simply allow a property to generate income do not have a quantifiable fair market value to deduct.  However, intangible rights that do “make a direct contribution to the going concern value of the business” do have a “quantifiable fair market value that must be deducted from an income stream analysis prior to taxation.”

The appellate court concluded that the assessor complied with Elk Hills, because he deducted the franchise and management fees from the income stream, excluding them from the valuation of the taxable property.  The assessor also excluded the hotel’s service centers from the property valuation, only assuming their presence in valuing the property as a full-service hotel.


For a discussion of the referenced Elk Hills case, please see our Legal Alert entitled, “California Supreme Court Update: Air Quality Emissions Reduction Credits May Be Considered in Assessing Unit Value of Power Plant, But the Fair Market Value of Credits Themselves Must Be Excluded from Assessment and Direct Taxation”, September 10, 2013.


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Brett L. Price | 661.864.3800