The Cost Approach: Hard Costs vs. Soft Costs in the Context of Tax Appeals

by: Anthony F. Della Pelle
5 Jun 2015

New home constructions often require that the property tax assessment which is then placed on a property be carefully examined.  Generally, property assessments for the following year are set forth by the municipal assessor on October 1.  However, if an improvement of a structure is completed after the regular assessment date of October 1, and presuming the property is not tax exempt, municipalities have an opportunity to capture that value by a mechanism known as an added assessment.

Photo courtesy of money.cnn.com

Photo courtesy of money.cnn.com

In Renna v. Highland Park, plaintiffs contested the added assessment determination for a newly constructed single-family residence by the Borough of Highland Park.  In 2011, plaintiffs purchased vacant land in Highland Park seeking to build a new residence.  Thereafter, they had  a single-family home constructed on the vacant land.  The home was completed and occupied by plaintiffs on December 1, 2012, after the valuation date of October 1, 2012.  Highland Park levied an added assessment of $229,000 on the subject property for the newly constructed improvement, which was prorated for the 12 months of tax year 2013.  Based on the Borough’s “equalization ratio”, the total assessment indicated a fair market value of the subject property of approximately $832,150.

During trial, plaintiffs’ expert argued that the subject property’s fair market value under the sales comparison approach was $700,000, and application of the cost approach would deem it as $685,000.  The Court, however, rejected both approaches.  The Court did not find credible the comparable sales selected by the expert and rejected the adjustments he made in his report, primarily because the subject property was a newly-constructed residence, while none of his comparable sales were of new or relatively new homes.

The Tax Court also rejected  plaintiffs’ expert’s cost approach because it failed to include an itemization of the “soft costs” in calculating the total actual building cost.  Plaintiffs’ expert’s report claimed that the total actual building cost was $373,000, including soft costs.  However, the construction loan covering the direct construction costs (i.e., materials, landscaping, grading, excavation, etc.) alone was $402,060, this loan did not cover payment for soft costs (i.e., legal fees, permit costs, architectural fees, engineering fees, building surveys, taxes, title fees, etc.).  As a result, the amount used was not deemed credible.

Another deficiency in plaintiff’s cost approach noted by the Court was the “lack of inclusion of entrepreneurial profit.”  Despite being built to be used as a single-family residence for the plaintiffs, the court indicated that an “entrepreneurial profit” should have been included.  However, due to plaintiffs’ expert’s failure to itemize soft costs in the cost approach, the court did not inquire further into the lack of “entrepreneurial profits.”  The Court did hint that “entrepreneurial profits” could have been inferred by the Court if plaintiffs’ expert accounted for the “soft costs” in his cost approach.

In sum, the Court concluded that both of the valuation approaches used by plaintiffs’ expert were flawed, and thus affirmed the Borough’s added assessment.

A copy of the Tax Court’s opinion is available here.

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