Here’s an interesting case that could signal an opportunity that valuation experts should know about. An appellate court in California has ruled that a county assessment of a luxury hotel improperly inflated its value by $2.8 million by using a flawed income approach that included nontaxable intangible assets.

Padded bill: According to court documents, the hotel, the Ritz-Carlton Half Moon Bay, was purchased in 2004 for $124 million. The tax assessor in San Mateo County used the purchase price amount and deducted the value of the hotel’s management and franchise fee to come up with a value of $116.9 million. The hotel challenged the property tax assessment, claiming that it included $16.8 million in nontaxable intangible assets. A valuation expert broke out the valuation of these intangibles as follows: (1) the hotel’s workforce ($1 million); (2) the hotel’s leasehold interest in the employee parking lot ($200,000); (3) the hotel’s agreement with its golf course operator ($1.5 million); and (4) goodwill ($14 million).

The hotel claimed that the income approach used by the assessor was “not appropriate for California property tax purposes.” It said that the proper method to exclude intangible assets from the assessment was not to simply deduct the hotel’s management and franchise fee, but to also identify, value, and deduct specific categories of assets in accordance with the state assessor’s handbook.

After the San Mateo County Assessment Board upheld the tax assessment, the hotel filed suit, seeking a refund of taxes paid and a remand to the board for a redetermination of property value.

But the trial court sided with the county and said there was substantial evidence supporting the conclusion that the assessment excluded the nontaxable value of the intangibles. The hotel appealed.

Decision reversed: “We conclude the income approach used by the assessor and approved by the board to assess the hotel violated California law,” the opinion says. However, the appeals court agreed with the county that the assessor had accounted for goodwill as an intangible value by deducting the management and franchise fee from the value. Therefore, the court said that only $2.8 million was improperly charged. It ordered the trial court to remand the matter to the board to recalculate the value of the property using the appropriate methodology.

Interestingly, the appellate court pointed to the assessor’s own expert, who conceded that the assessor’s approach did not remove all intangible assets and rights. His report stated “the majority of the property’s business value has been removed through the deduction of the management fee.” At a hearing before the county board, the expert admitted that “other components” such as “labor in place” “should be deducted” in addition to the management and franchise fee.

Find a full discussion of SHC Half Moon Bay, LLC v. County of San Mateo, 2014 Cal. App. LEXIS 446 (May 22, 2014), in the August edition of Business Valuation Update; the court's opinion will appear soon at BVLaw.