The gold standard for determining market value in property tax assessments has always been the sale of the subject property.  We all know that a willing buyer and a willing seller will ultimately determine the best measure of an asset's worth.  Almost all tax statutes use this definition of fair market value.  But that soon may change.

Over the years, the assessing community has been able to aggressively attack many sale transactions that would result in reduced property tax assessments.  The maxim typically heard and relied upon is:  "every high sale is a market transaction and every low sale is a distress transaction that cannot be relied upon for tax assessmetn purposes."

This issue was recently tested in the New Jersey Tax Court.  A Fortune 500 company with a sizeable portfolio contested the assessment of a large office complex.  After several days of trial, the parties negotiated a settlement.  While the settlement papers were being signed, it was unexpectedly announced that the same property had been sold at almost double the agreed upon settlement figure.  The taxing jurisdiction made an immediate application to set aside the settlement.

The facts of the transaction were fairly straightforward.  The taxpayer was the sole tenant of the property since its construction.  The taxpayer agreed to buy the property from the owner and close title within nine days from the execution of the sales contract.  Prior to the closing date, the contract was assigned to a third party.

The taxpayer set up the transaction as a 1031 tax-free exchange.  This allowed the taxpayer to shelter gain received from the recent sale of another large office building in its portfolio.  Under 1031, sellers of investment-grade real estate may defer paying capital gains by using the proceeds from one sale as an investment in another similar property or properties.  The seller has 180 days from the original closing date to complete the exchange.  Also, within 45 days of the closing the taxpayer must provide the IRS with a list of three or more potential replacement properties.

Within 45 days, the property was listed by the taxpayer as one of 19 replacement properties.  In the ensuing court proceeding, the taxpayer successfully argued:  the transaction price was well in excess of market value; and the motivation of the taxpayer was to shelter the gain acquired from the other sale.  The sale price of the property was of secondary importance.

The Court agreed with these arguments.  It determined that the sale of the property was clearly motivated by business, rather than real estate considerations.  The Court indicated that the ability to complete a tax-free exchange within 180 days of the date of an original closing places enormous pressure on a taxpayer.  Further, it determined that the basis of the transaction was the ability to defer gains from another sale.  This sale did not take place in keeping with normal market practice because it was between a lessor an a lessee.

This case is important because it is one of the first to speak out on the nature of tax-free exchanges and the impact of those transactions on property-tax assessments.  Too often, taxpayers reluctantly agree to exorbitant assessments because they believe that a sale is impossible to defend.  Such beliefs will cost them money, unnecessarily.