Environmental Contamination and its Impact on Market Value and Property Assessments -- an Updated View
By: John E. Garippa, Esq., Senior Partner and Brian Fowler, Esq., Associate,
Garippa, Lotz and Giannuario, P.C., Montclair, New Jersey
As tougher government environmental regulations are introduced they significantly affect the value and use of contaminated property. Taxpayers are required to spend large sums of money to remediate contaminated properties and restore them to a clean state so that they can be sold, or potential buyers may lower their offering price dollar for dollar for the cost of cleanup, or refuse to buy the property at any price. Often the cost to cleanup a property with extensive environmental contamination exceeds the value of the property. Does this mean that the property is worthless in a tax assessment setting? Can taxpayers just subtract the expenses of remediation from the value of a property if it were clean to arrive at a value for tax assessment purposes? Courts throughout the United States are struggling to determine a methodology for valuing these properties, in various scenarios, and their approaches are varied and far-reaching. Courts in the past have been hesitant to reduce tax assessments of contaminated properties because such reductions it is argued are contrary to the policies underlying environmental protection legislation.1 The purpose of this paper will be to examine some of the most recent court cases on the issue of environmental contamination and it's impact on property assessments. Rather than reviewing all of the prior court decisions on this issue, we have focused on the most recent decisions over the past several years.
Courts have addressed the impact of contamination on the valuation of property for tax assessment purposes. Those that have contended with this issue have usually acknowledged that environmental contamination has an adverse affect on property values or that an assessor must consider the effect of contamination on the fair market value of the property. In Boekeloo v. Board of Review of the City of Clinton, 529 N.W.2d 275 (1995) a taxpayer discovered groundwater contamination on his property that was being used for the operation of a tavern. When the Clinton City assessor valued the property he refused to consider the existence of contamination. He valued the property at $235,220 using the cost approach. The taxpayers argued that the value of the property was zero due to the existence of contamination and the inability to sell the property. The court decided that environmental contamination would in deed have an effect on the value of property, but in this case the taxpayer had not presented any evidence on actual expenses or estimated costs to cure the contamination, or that the contamination had affected his business operations. Because the taxpayer was unable to establish the correct value of their property through proper proof, he did not carry their burden of proof and the court affirmed the assessment.
The Supreme Court of Nebraska in Garvey Elevators, Inc v. Adams County Board of Equalization, 621 N.W.2d 518 (2001) upheld that the "value in use" methodology was an appropriate way to value a contaminated property. Here a property owner had land improved with grain elevators that was badly contaminated with carbon tetrachloride. On site remediation was estimated to cost $2.3 million, which exceeded the assessed value of $1,965,375. Garvey protested the assessment with the Board of Equalization, who reduced the value of the property to $1 million. The Tax Equalization Review Commission (TERC) upheld the Board's decision. Taxpayer argued for a dollar for dollar reduction in value, but did not have approved remediation plans and no capital expenditures were made; therefore the Court viewed the costs as speculative as of the assessment date.
In analyzing Garvey's evidence to determine if the Board acted unreasonably, the TERC determined that the preferred method of valuing contaminated property (to deduct the remediation costs from the unimpaired value of the property) could not be used because it would place a negative value on the property while the taxpayer actively used the property. It was also determined that because the taxpayer did not have an immediate goal of implementing a remediation plan, a dollar for dollar reduction was inappropriate. Because the preferred method of valuing contaminated property was unavailable to the TERC they instead relied on the fact that the property was "actively used" to determine a value. TERC decided that the "value in use" methodology be used because of the active use of the property, and that it would most nearly reflect the market value of the property. TERC looked at the income generated by the property as evidence that the property had value in use to the taxpayer.
The Supreme Court of Utah has also accepted a "value in use" valuation method for contaminated residential properties. In Schmidt v. Utah State Tax Commission, 980 P.2d 690 (1999), the taxpayer's home, located on 2.7 acres, had been built on a smelting plant property. It was determined that the land was contaminated, and it was estimated to cost $1,042,252.05 to clean up a property assessed at $789,370. The taxpayer argued that the property should be valued at zero and submitted an appraisal report that valued the property at negative $334,000. The taxpayer continued to live at the residence with their children while they challenged their assessment.
The Tax Commission in Schmidt accepted the fact that that using the normal methodology of calculating value of a contaminated property would result in a negative value.2 However the Commission determined that a negative value implies that the property is uninhabitable; in this case the property was utilized and thus had some positive value. The Commission decided to treat the land and home separately because the building was utilized, not contaminated, and the harm to the overall value of the property was due to the contamination in the soil. The Commission opted to determine the assessment by setting the value of the real property at zero, and value the house at the standard replacement cost new less depreciation since the house was habitable, in use, and not contaminated.
The Minnesota Supreme Court has upheld a valuation determination reducing a contaminated property to $0. In Westling v. County of Mille Lacs, 543 N.W.2d 93 (1995), the petitioner owned an office warehouse structure where they remanufactured automotive parts. The property was contaminated by tetrachloroethene, a degreaser used in the remanufacturing process. Petitioner had spent more than $1,085,000 to clean up the site, with expenses estimated to be over $3,500,000. The Supreme Court affirmed the decision of the tax court that the market value of the property should be reduced to $0, based on the estimated cost of cleaning up the property and the stigma discount for the environmental damage.
While the Minnesota Supreme Court has affirmed a valuation of $0, owners of contaminated property are not "tax free." In 1993 the Minnesota legislature enacted a new "contamination tax" imposing an annual tax on the "contamination value" of real property in the state.3 The tax has many of the same features as an ad valorem property tax, but is discontinued when the taxpayer provides the assessor with a written determination by the Minnesota Pollution Control Agency stating that all of the requirements of a response plan have been satisfied.4 The Supreme Court of Minnesota upheld this legislation in 1998.5
In Westling v. County of Mille Lacs, 581 N.W.2d 815 (1998) the taxpayer challenged the constitutionality of this tax based on the contamination value of their commercial real property. The Minnesota Supreme Court upheld the constitutionality of the tax. The court determined that the presence of environmental contamination, along with the responsibility for clean up, were genuine and rational bases for creation of a contamination tax, and that by creating this class of taxpayers there was no violation of the equal protection clause. It was argued by the taxpayer that the tax violated the "uniformity clause" of the Minnesota Constitution and the United States Constitution and that it created an arbitrary classification. The court found that the legislature carefully chose three different criteria to create a "class within a class" to recognize the "unique character" of the property at issue. The first criterion is that the property have a reduced value due to the presence of contaminants. Second, the taxpayer must have been found to be the responsible party for the presence of the contamination and finally, an approved response plan must be implemented for the contaminated property.
The Minnesota Supreme Court befriended property taxpayers of contaminated property last year when they distinguished stigma from contaminated property and affirmed a discount that is not limited by statute. In Dealers Manufacturing Co v. County of Anoka, 515 N.W.2d 76 (2000) the Court was able to distinguish "stigma" because a stigma factor can attach to a property whether contaminants are present, threatened, or totally absent. The property that was the subject of the property tax dispute was a manufacturing plant site with groundwater and soil contamination. The taxpayer had spent $350,000 to clean up the property against a total cleanup cost estimate of $560,000. The county assessed the market value of the property at $1,336,600. During the clean up of the property the taxpayer obtained an appraisal report that concluded that the property should be subject to a devaluation factor due to the risk of liability for clean up costs and the possible lack of mortgageability. Minnesota has determined that a property may have a "contamination value" for the means of determining property taxes but places a cap on deductions from market value relating to contamination at the cost of a reasonable remediation plan.6 The Court concluded that stigma might attach to a property that is not itself contaminated, but may present a perception of liability, or risk of transferability and thus would not fall into the category of "contaminated." The court also found that "contamination value" is defined by the cost of clean up and since stigma can exist without contamination being present on the property the legislature could not have intended for this value to be included and capped by the property's "contaminated value."
Perhaps the most significant recent case on this issue is Mola Development Corporation v. Orange County Assessment Appeals, 80 Cal. App. 4th 309 (2000). This is an opinion by the Court of Appeals in the State of California that examines many of the environmental decisions rendered by other courts throughout the United States. In this case, Mola Development bought 20 acres of prime vacant land for multi-use development. Mola knew that the vacant property was riddled with toxic contamination by a former owner, but agreed to pay $46 million with the understanding that the prior owners would fully cure the contamination. This cost to cure was estimated at $16.7 million over a ten-year period. The assessor never questioned the $16.7 million cleanup figure, but rather disputed whether the cleanup should be taken off the top of the uncontaminated value of the property. The Superior Court ruled that the tax board should have deducted the entire $16.7 million figure from market value in determining the assessment.
In affirming the Superior Court's determination, the Court of Appeals made numerous pronouncements on the state of environmental law. It rejected the underlying notion that fair market value is somehow dependent on the innocence of the landowner.
The idea of 'innocence' as the talisman for a reduction in the valuation assessment was properly rejected by the Appellate Court, albeit in dicta, in the Firestone case. Id. at 317.
The Court went on to outline the basic underpinnings of fair market value by delineating that it would be hard to imagine any potential rational buyer in the real world paying more than the unimpaired value of the property. Here the Court focused on the fact that an intangible was involved in this property transaction. That intangible was the indemnity agreement entered into by the parties.
In the case before us, for example, it is not accurate to say that Mola paid $46 million in 1987 for "the property" and just stop there. Mola paid $46 million for the property and for an important intangible - an indemnity agreement. The seller received $46 million minus the value of the seller's agreement to clean it up. (Of course, using indemnity agreements only works when sellers have deep pockets, such as Beckman Instruments and Prudential). Id. at 320.
The Court continued on by stating that any buyer contemplating the contingency of cleaning up contamination would probably finance the operation. Therefore, utilizing the present value of cost to cure under this scenario was acceptable, just as the lower court did in this matter.
The Court also focused on the errors in logic committed by other state courts in failing to understand the impact of environmental contamination on tax assessments. In specifically focusing on the New Jersey Supreme Court and its failure to properly understand these issues in the Inmar decision,7 the Court stated as follows:
However, it is important to distinguish, as the Inmar court perhaps did not take the greatest pains to do, the idea of present value from the idea of deducting costs of core. In this regard, it appears that the Inmar court may have fallen into the same logical trap that the assessor fell into in the case before us, when the assessor opined that it was unfair to "take the full sixteen million dollars out in one year." Thus, instead of deducting the present value of $16.7 million from the fair market value of the property as if uncontaminated to arrive at its assessed value in a given year, like 1990, the assessor seemed to be advocating dividing the $16.7 million by the 10 years of cleanup, then taking the $1.67 million result (or its present value) and deducting only that from the uncontaminated value of the property for each of the next 10 years. * The assessment should reflect the cost of cure - because every year's assessment reflects a hypothetical open market transaction in fee. It is precisely the full fair market value which is the subject of every year's assessment. Id. at 321-322.
Thus, the Court fully delineated that the critical issue in property tax assessment is based on a hypothetical market transaction, not the taxpayer's benefits. Any recovery the taxpayer may have for that pollution/contamination is of no relevance in determining the market value of the property for assessment purposes. The additional indemnification agreements that may be a part of these transactions are "intangibles" that cannot be taxed as the value of the property.
In Gulf Coast Recycling, Inc v. Turner, 753 So.2d 712 (2000) the property at issue was an apartment complex in Florida that had been placed on the Superfund list by the United States Environmental Protection Agency. The Gulf Coast Lead Company at the direction of the County Health Department contaminated the property from the burial of battery cases. The taxpayer argued that the cost of the potential clean up exceeded the value of the property, that no potential purchaser would buy the property, thus the property was without value. The property appraiser for the taxing jurisdiction placed a value of $1,704,166 on the property ignoring contamination. The court determined that the appraiser did not consider all of the factors required by statute when reaching his assessment. In particular, he failed to consider the property's present cash value and the condition of the property in its contaminated state. Gulf Coast presented persuasive evidence to the court that the cost to remediate the property would exceed the value of the property. Ultimately, the District Court of Appeals for Florida determined that the present cash value of property is the amount a willing purchaser would pay a seller for the property minus the cost of any contamination, and if a property owner can present persuasive evidence that a property is without value, then that fact must be considered.
The Superior Court of New Jersey, Appellate Division in Badische (BASF) Corporation v. Town of Kearny, 17 N.J. Tax 594 (1998) set mandatory principles for a court to consider when assessing the tax value of unused, contaminated property that is subject to mandatory cleanup at the owner's expense at an estimated but undetermined cost. In BASF v. Kearny the taxpayer appealed the valuation of an unused property that had been environmentally contaminated after years of discharging chemical waste into the ground. The crux of the valuation issue was whether the property's value had been adversely impacted by environmental contamination. BASF argued that there should be an adjustment to the value of the property based on environmental contamination. At the time of the trial, there were extensive contamination reports on both environmental contamination and asbestos contamination, although no formal cleanup agreement had been recorded with the Department of Environmental Protection. Because there was no formal cleanup plane in place, the trial court excluded all cleanup costs. BASF appealed and the Appellate Division remanded the case to allow BASF to benefit from a deduction for the asbestos removal costs and the reconsideration of environmental contamination adjustments as valuation factors. The Appellate Court deferred to the tax court's expertise to set a proper method to determine the effect of cleanup costs on environmentally contaminated land. Incredibly, on remand to the tax court, the Judge once again refused to consider the environmental contamination of the property and formulate a proper method for determining the costs of cleanup of contaminated land. BASF challenged the Tax Court decision again. This time the Appellate Division used the opportunity to set the following principles to determine the value of unused environmentally contaminated property: first, the cost of remediation cannot reduce the market value of the property on a dollar for dollar basis, second, market value is affected by environmental contamination and the effect cannot be ignored, third, when determining a value for contaminated land non-classical, flexible approaches to valuing such property are required and should be employed. Finally the Appellate Division determined that treating the cost of cleanup as a depreciable capital improvement contains the seeds of useful doctrine.
In the case of In re: Custom Distribution Services Inc, City of Perth Amboy v. Custom Distribution Services,Inc., 224 F.3d 235 (3rd Cir. (N.J.) (2000), the Federal Court of Appeals had an unusual opportunity to examine the issue of contamination in property assessment.
Taxpayer purchased property that was contaminated and subsequently listed as a "Superfund Site." Taxpayer eventually filed for reorganization under Chapter 11 of the Bankruptcy Code in 1994 and filed a tax appeal in 1996 to challenge the property tax assessment, arguing that the contamination affected the value of the property.
The taxing district argued that where environmental contamination affects valuation the testimony of an environmental expert is required. The Court disagreed and determined that while a real estate appraiser cannot value a property without proof that contamination exists, the appraiser, although not qualified to make a finding that the property is contaminated, can testify about the valuation of the property as affected by contamination, if he relies on expert determinations. To make such as determination an appraiser may rely on letters prepared by the United States Environmental Protection Agency and New Jersey Department of Environmental Protection even thought those letters are not submitted into evidence. The Court determined that according to Federal Rule of Evidence 703, an expert may base their opinion on facts or data made known to them before trial if they are of a type reasonably relied upon by experts in the field in forming opinions, and the facts or data need not be admissible into evidence.
The growing reality throughout the United States is that environmental contamination must be accounted for in a property tax assessment, even though some jurisdictions make it as difficult as the biblical metaphor of "squeezing a camel through the eye of a needle."
1 Firestone Tire & Rubber Co. v. County of Monterey, 223 Cal.App.3d 382 (1990).
2 The normal method of calculating the value of contaminated property is to deduct the costs of remediation from the value of the property as calculated before any deduction for contamination.
3 Minn. Stat. Sec. 270.91-.98 (1996).
4 Westling v. County of Mille Lacs, 581 N.W.2d 815 (1998).
5 Id.
6 Minn Stat. Sec. 273.11
7 Inmar Associates, Inc. v. Borough of Carlstadt, 112 N.J. 593 (1988).