commercial real estate · Malls · Office Properties · Retail leases · Shopping Center · Uncategorized

Considering the proper treatment of tax abatements and incentives in your leases

I have the honor of serving on our city’s development authority. It is a recent appointment, so I cannot take any credit for the great things that have been done already. As part of the appointment, I was required to take a class that included a couple of hours on tax incentives and bond financings.

While I am a neophyte serving on an incentive granting authority, we have dealt with the aftermath of abatements and incentives on hundreds of properties over the years. Using the word “aftermath” is actually intentional because, so often, the true intended benefit for the intended recipients never actually comes to fruition. (And, because I am a lease language geek, the word “aftermath” is especially meaningful as the reason it often doesn’t come to fruition is because of what happens “after math”!)

There are numerous reasons for developers asking for and governments granting incentives, but most can be boiled down to two words – but for. The area would remain or become blighted “but for” the incentives. The employer might not consider locating here “but for” these incentives. It’s an oversimplification of a lengthy process, but it is fairly accurate.

One of the simplest forms of incentives is a tax abatement. There are countless numbers of ways the abatements can be structured – full and partial, of all taxes or of one or more categories of county, school or town/city/village and so on. But, the intent is often to provide some financial incentive to the developer to help with the costs of certain “but for” necessary improvements. Something to the effect of taxes being $100,000, and they are waived for a 10 year period. Or taxes are $100,000, and they are waived at 100% for the first year, reducing by 10% per year over a 10 year period. Or, taxes are $100,000, and they will remain at that level for a 10 year period despite the fact that the property is expected to increase in value by 5, 10, 20 times once the development work is completed. In our 10 year, $100,000 per year example, the intent is to get the $100,000 per year to the landlord.

In a typical lease, what would happen? The tenant is required to pay a prorata share of taxes. The landlord would get a tax bill for $0, and the tenants would then be billed a prorata share of $0. While you could argue that the landlord was able to get additional base rent during the abatement period because the tenant did not have to pay tax, the true $100,000 intended benefit may not have been realized.

However, if the landlord anticipated this tax abatement, the abatement itself could be addressed as a separate issue in the lease. Ultimately, the tenant would be required to pay a prorata share of taxes, with taxes defined to include what taxes would have been absent any abatement. In that case, the tenants would then be billed a prorata share of $100,000 (what taxes would have been absent any abatement), would collect the tenants’ prorata shares and then would retain those amounts because there is no tax bill.

Again, an oversimplification of the issues. However, incentives, including abatements, only really work if the intended benefit is received by the intended recipient. This can be done only by properly considering the lease language – before the lease is executed.

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