Knowing the Waters – Real Property Taxes, Real Property Tax Exemptions, Leasehold Excise Tax and Leasehold Excise Tax Exemptions

The mix of port district tenants is shifting from primarily industrial or commercial uses to a much wider range of uses.  So, this month we look at real property taxes, real property tax exemptions, leasehold excise tax and leasehold excise tax exemptions. Many are surprised to learn that many not-profit organizations typically exempt from real property taxes may not be exempt from leasehold excise taxes and vice versa.

Real Property Tax.  In Washington, state and local governments rely on real property taxes for significant portions of their budgets.  Washington applies a “use based” approach to exemptions from real property taxes meaning the exemption is based on the “use” as opposed to the “status” of the property owner.  While many nonprofits are exempt from federal income tax, these same nonprofits are not exempt from Washington state real property taxes unless the “use” of the property falls within an exemption.  The one exception to this rule is the Washington State Constitutional provision that real property owned by governments, including port districts, is not subject real property tax.

Real Property Tax Exemptions.     Chapter 84.36 RCW contains the real property tax exemptions.   The list is long and includes property used for cemeteries; churches; parsonages; nonprofit blood and tissue banks; nonprofit homes for the aging or the developmental disabled; nonprofit emergency or transitional housing to low-income homeless persons or victims of domestic violence; nonprofit museums; nonprofit medical research or training of medical personnel; and, schools and colleges.

Leasehold Excise Tax.  Since publically owned real (and personal property) is exempt from property tax, the leasehold excise tax was enacted to “fairly compensate government units for services rendered to such lessees of publically owned property” (RCW 82.29A.010).  According to the Department of Revenue generally, 53% of the tax goes into the State General Fund and 47% of the tax is returned to the county and city in which the leased property is located.  The 12.84% tax is collected on any “leasehold interest” except those leases subject to exemptions.  The Department of Revenue can also consider all value flowing from a tenant to the government in the contract in calculating the “taxable rent” including the actual rent amount, any required expenditure by the tenant for the protection of the government’s interest, any required expenditure by the tenant for the improvement of the government’s property and even the residual value of tenant improvements if those improvements automatically become the property of the government when the lease terminates.

Reduce Rent and Leasehold Excise Tax.  For a wide variety of reasons, including economic development and employment stimulation, rents are sometimes reduced.  RCW 82.29A.020 and accompanying regulations allow the Department of Revenue to adjust the rent to a fair market value number for the purpose of assessing leasehold excise tax.  This is the concept of “taxable rent.”   The Department of Revenue can consider all value flowing from a tenant to the government in the contract in calculating the “taxable rent” including the actual rent amount, any required expenditure by the tenant for the protection of the government’s interest, any required expenditure by the tenant for the improvement of the government’s property and even the residual value of tenant improvements if those improvements automatically become the property of the government when the lease terminates.

Leasehold Excise Tax Exemptions.  The leasehold excise tax exemptions are found at 82.29A.125 – 138.  The list is much shorter than the real property tax exemption list.  These exemptions look to me to be the result of specific legislative action and include the lease of public property for electric vehicle infrastructure, public utilities, regional transit, subsidized housing owned by governments, university housing, nonprofit fair associations, manufacture of “superefficient airplanes,” amateur radio repeaters and anaerobic digesters.  The interesting point here is that the long list of exemptions from real property tax do not carry over to the list of exemptions for leasehold excise tax.  There is some overlap but there are many differences.

Best Practice for Leasehold Excise Tax Issues.  As port leasing moves from the traditional industrial and commercial tenants I recommend the following “best practices”.

• Carefully assess the applicability of leasehold excise tax to the lease activity. This analysis will allow for an informed discussion with the prospective tenant.
• Understand that a use may exempt real property from property tax but not leasehold excise tax or visa-versa.
• Review the port’s standard lease documents to make sure that provisions requiring tenant performance (for example insurance) are carefully drafted to avoid the value being included as contract rent.
• Always include language that the tenant is responsible for “all applicable leasehold excise tax” so that no matter what the tenant has to pay the leasehold excise tax if determined by the Department of Revenue.  For those uses believed to be exempt, never go beyond stating that “it is believed that the tenant’s use is exempt from leasehold excise tax.”