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Property Tax Abatement in Tennessee via PILOTs

On December 4, 2012, Metro Council passed an economic incentive for Nashville-based HCA Holdings, Inc. (“HCA”) that is estimated to total $66 million over 20 years and is one of the largest Metro Nashville has ever offered to a company. See “HCA incentives package sails through final council vote, ” Nashville City Paper, December 4, 2012. One of the components of this package authorized the Industrial Development Board of the Metropolitan Government of Nashville and Davidson County (“Metro Nashville IDB”) to enter into a payment-in-lieu-of-taxes (PILOT) agreement for the benefit of West End Summit Development, LLC (the “Developer”) and the HCA affiliates known as Parallon Business Solutions, LLC, HealthTrust Purchasing Group, LP, and Sarah Cannon Research Institute, LLC (collectively, the “HCA Affiliates”). See Ordinance No. BL2012-297 (Matthews & Langster). The agreement provides for a one hundred percent (100%) real property tax abatement of up to $3 million per year for fifteen years, with an additional five year extension so long as an HCA Affiliate continues to occupy the project. If extended for five years, the total potential amount of the property tax abatement would be $60 million over the life of the agreement.

However, as of today, the project has stalled and HCA is reportedly exploring its options. See “HCA ‘exploring all options’ as West End Summit stalls, ” Nashville Business Journal, September 13, 2013. Given this recent development, I thought I would go back and revisit what HCA stands to lose should this project fall through. This article will only review the PILOT terms of the HCA incentive package and outline how property taxes are abated in Tennessee through the use of PILOTs.

PILOTs – Generally

A PILOT agreement is, generally, an agreement that is used to transfer a public or local government’s tax exempt status to a private entity. The property is not on the local government’s tax rolls because it belongs to a tax exempt entity, even though the property is being leased to and used by a private entity, and the private entity receives the benefit of this tax abatement. These agreements are typically used by local governments as an incentive to induce the relocation of a new business or the expansion of an existing business in the community.

How They Work

The Metropolitan Government of Nashville and Davidson County (“Metro Nashville”) cannot directly abate property taxes for private entities as an absolute waiver of ad valorem taxes is illegal under the Tennessee Constitution. The Tennessee Constitution generally prevents local governments from directly abating property taxes stating that “all property, real, personal or mixed shall be subject to taxation.” See Tenn. Const. Art. II, § 28.

However, the Tennessee Constitution also recognizes that property owned by a local government can be exempt from taxation. See Id. Relying on this exemption, a property tax incentive program can be achieved by titling property in the name of the local government and then leasing the property back to the private entity. Ergo, the local government owns the property which is now exempt from property taxes and the private entity receives the benefit of this abatement.

Tax abatement agreements in Tennessee are generally implemented through industrial development boards (“IDB”s). Pursuant to the Industrial Development Corporations Act, codified at Tenn. Code Ann. §§ 7-53-101 – 316 (the “Act”), the State of Tennessee authorizes the incorporation of public nonprofit corporations, IDBs, by cities and counties in Tennessee. Under the Act, these IDBs have the authority to acquire, whether by purchase, exchange, gift, lease or otherwise, and to improve, maintain, equip and furnish, land or building “projects” in Tennessee, and to lease such projects to a private entity. Because IDBs serve a public function, these projects are therefore exempt from taxation. See Tenn. Code Ann. § 7-53-305. Therefore, the ownership interest in any property conveyed to an IDB and leased to a private entity will be exempt from property taxes.

Thus, in Tennessee, private entities may receive economic incentives through tax abatement agreements with IDBs. Through these PILOT agreements, projects are exempt from property taxes and instead make a payment-in-lieu-of-taxes.

To create an incentive through a bond-lease transaction, an IDB will issue industrial development revenue bonds to finance the acquisition, construction and development of a project that it will ultimately lease back to the private entity. Using the proceeds of the bonds that it issues, the IDB acquires title to the project to which the tax incentives will apply. The lease payments amortize the bonds and the private entity typically will own the project at the end of the lease. This is what has been proposed in the HCA incentive package.

HCA’s Incentive Package

In accordance with Ordinance No. BL2012-297, the Developer will enter into a PILOT agreement with the Metro Nashville IDB to lease the project who will in turn sublease 475,000 to 500,000 square feet of the project to the HCA Affiliates. As noted above, this PILOT agreement provides for a one hundred percent (100%) real property tax abatement f up to $3 million per year for fifteen years, with an additional five year extension as long as an HCA subsidiaries continues to occupy the office space. If extended for five years, the total potential amount of the tax abatement would be $60 million over the life of the agreement. The tax abatement would take effect upon the execution of the lease with the Metro Nashville IDB at the time the Metro Nashville IDB issues the industrial development revenue bonds required to finance the costs associated with this project.

After accounting for the $60 million tax abatement, Metro Nashville will still potentially net $17,599,215 in new real property taxes over the life of the PILOT agreement, plus approximately $2 million in additional personal property taxes.

Unique terms found in this PILOT agreement:

  • Section 3(a)(ii) & Section 3(c) – The PILOT Deduction and PILOT Deduction Credit. If the property taxes that would otherwise be owed to Metro Nashville fall below $3 million in a given year, the lessee will have the ability to “bank” the difference and apply it against PILOT payments in future years. This means that the HCA Affiliates would get the benefit of the full $3 million abatement per year even if the property value falls or the tax rate is lowered.
  • Section 3(a)(iii) – Job Benchmarks. It is required that a certain number of employees work in Davidson County as a result of the project in order for the HCA Affiliates to receive the full amount of the abatement. The job benchmarks are 1,000 full-time equivalents (“FTEs”) in 2016, 1,300 FTEs in 2017, and 1,500 FTEs in 2018 and subsequent years. Failure to meet these benchmarks would result in a $300,000 reduction in the amount of the abatement for every shortfall of 100 incremental positions. Employees that are currently working in Metro Nashville do not count toward the benchmark.
  • Section 5 – DBE Requirements. This is the first time a Metro Nashville PILOT ordinance would require the creation and implementation of a small, minority, and disadvantaged business program (“DBE Program”). The DBE Program must have a participation target of at least 20% of the project’s hard construction costs. The Developer will be required to make periodic reports regarding the DBE Program to the Metro Nashville council and the minority caucus.

Additional information on various PILOT programs in Tennessee:

The Great Tennessee-Georgia Border War of 2013

On March 25, 2013, Georgia senators passed House Resolution 4 (“HR 4”), a resolution which proposed settlement of the boundary dispute between the State of Georgia and the State of Tennessee. The resolution attempts to settle the long running dispute about the Tennessee-Georgia state line and clarify Georgia’s access to the Tennessee River. It also directs the Georgia attorney general to file suit in the U.S. Supreme Court (based on Article III, Section 12 of the U.S. Constitution) if Tennessee does not accept Georgia’s offer by the last day of next year’s General Assembly session.

Everyone knows that the ultimate issue here is water. The current border cuts off Georgia from access to the Tennessee River. The Tennessee River has been long coveted by Georgia as a source of more than enough water to meet the demands of metro Atlanta’s ever growing population.

Georgia’s argument is that the boundary between Tennessee and Georgia was originally set at the 35th parallel until an incorrect survey in 1817 set it slightly to the south. Were the Tennessee-Georgia state line moved to precisely follow the 35th parallel, the line would be shifted northward to points over a mile north of its present location. Nonetheless, the proposed settlement from Georgia offers to claim only a tiny unpopulated part of Tennessee at Nickajack Lake (enough to withdraw water from the Tennessee River). Georgia would make no claims on the rest of the area up to the 35th parallel.

Georgia has raised this issue several times to no avail. Georgia made efforts in the 1890s, 1905, 1915, 1922, 1941, 1947 (which similarly authorized the Georgia attorney general to bring suit

to the U.S. Supreme Court), 1971 and 2008 to resolve this dispute. Each time Tennessee did little or nothing in response. Based on recent statements by Tennessee Gov. Bill Haslam and the Tennessee Legislature. it seems that Tennessee will be taking the same approach in response to HR 4.

A border lawsuit between Georgia and Tennessee accepted by the U.S. Supreme Court would easily become one of the most significant border cases in our nation’s history. Furthermore, the political and economic effect of moving the Tennessee-Georgia border to the north by a mile would be massive.

Nov 19 2012

Oral Modification to Construction Contracts

Construction contracts typically contain provisions that explicitly require the parties to reduce all modifications to the contract into writing. These “additional work” provisions are written to prevent the enforceability of oral modifications to the contract and, hopefully, prevent both parties from a potential loss. However, the Tennessee Court of Appeals recently allowed the parties to modify a construction contract by oral agreement even though the original contract explicitly required modifications to be in writing.

In Song & Song Corporation, and Jin Y. “Jim” Song, Individually v. Fine Art Construction Company, LLC, et al.. No. W2011-01708-COA-R3-CV (Tenn. Ct. App. June 14, 2012), a property owner hired a general contractor to perform construction work on a commercial building. The contractor later performed additional work deemed necessary to install missing fire dampers without written authorization from the property owner to do so. When the work on the building was completed, the property owner refused to pay for the additional work pertaining to the fire dampers and the contractor sued.

The property owner argued that the lack of a written change order allowed him to avoid his obligations here as the contract included the following provision: “[T]his Agreement may not be modified except by separate written instrument executed by Owner and Contractor.” The Court of Appeals disagreed and found that the parties had in fact orally agreed for the contractor to perform the additional work, said oral agreements were valid and enforceable, and the property owner could not avoid his obligations thereunder simply because of the lack of an additional signed writing. The contractor was awarded full payment for the additional work despite the absence of written authorization.

Tennessee courts generally follow the rule that allows contracts to be orally modified even if the contracts specifically state that the contract can only be modified in writing. Even where the written contract prohibits oral modifications of the agreement, oral alterations will still be given effect by the Courts if otherwise valid. Regardless, contractors are still advised to document “additional work” agreements, utilize change orders, and adhere to the provisions of a construction contract to avoid future payment disputes.

Oct 23 2012

Tennessee’s Greenbelt Law as a Tax Shelter

Pursuant to Tennessee’s Agricultural, Forest and Open Space Land Act of 1976, open land that exists near growing commercial and residential areas may be threatened by urban sprawl and the system of property taxation. This act has come to be known generally as the “Greenbelt Law.” As a result of the Greenbelt Law, open space real property that might otherwise be classified as residential, commercial, or other higher density use and thereby be subject to higher property taxes, may be eligible for classification as one of three different types of land: Agricultural Land, Forest Land, or Open Space Land. The result is a dramatic savings in property taxes — often resulting in an Owner having to pay only pennies on the dollar — designed to encourage production of valuable food, prevent loss of family farms due to higher taxes, and provide relief from urban sprawl and green spaces for enjoyment of people who would not normally have access to such areas.

There are limitations as to what qualifies for greenbelt classification. The law limits the amount of land eligible for enrollment to 1500 acres per Owner per county. Although an “Owner” may be more than one person, an Owner that owns greenbelt property with others, or as part of a corporation, is only credited with his or her proportionate share of the acreage towards the 1500 acre cap. If the use of the property changes, the Owners are then required to pay the taxes that would have been paid on the full unrestricted value of the land (“rollback taxes”). To be clear, rollback taxes are not a penalty. Rollback taxes are only a recapture of the amount of taxes saved by Owners over a certain period of time that the land qualified as Agricultural Land, Forest Land, or Open Space Land. For Agricultural Land and Forest Land, authorities can recoup up to three years in back taxes; for Open Space Land, authorities can recoup up to five years in back taxes. See Tenn. Code Ann. § 67-5-1008(d).

To be effective for the current tax year, Owners of property who are applying for the first time for greenbelt classification must apply on or before March 1. Owners who fail to file by the deadline date will result in the property not qualifying for the current tax year. There is no appeal procedure for late filed applications. However, the denial of a timely filed application is appealable to the county board of equalization. Once the property is classified as Agricultural Land, Forest Land, or Open Space Land, reapplication is not required so long as the ownership as of the assessment date (January 1) remains unchanged.

The Commercial Appeal recently reported on the use of the Greenbelt Law as a tax shelter, citing the estates and hobby farms of individuals such as AutoZone founder J.R. “Pitt” Hyde, Wynonna Judd, former University of Tennessee football coach Phillip Fulmer, and Nashville lawyer E. Warner Bass as examples. See Marc Perrusquia, Grant Smith, Cash crop: Tennessee farmland protection law shelters taxes for rich and famous. Commercial Appeal, October 14, 2012. The article closes with summaries of the recent legal battles over the Greenbelt Law, as well as a review of similar restrictions in other states. In a similar article, the Knoxville News Sentinel recently reported on the massive use of the Greenbelt Law by individuals in Williamson County. See Marc Perrusquia, Trees help shade Tennessee’s wealthy from taxes. News Sentinel, October 18, 2012.

Oct 11 2012

Agricultural Zoning and the Right to Farm Act: Agritourism equals Agriculture in Tennessee

In a decision issued early this year by the Tennessee Court of Appeals, the court considered a dispute between an individual operating a farm as Maple Lane Farms and a neighboring property that claimed the farm-based activities were mostly commercial, not agricultural. According to the neighbor, the noise from the commercial activities interfered with her sleep and reading. The neighbor testified as follows:

“Q. How has the noise bothered you? What is it about the noise that has bothered you?

A. Well, the music was just very, very, very loud, you know, like I could almost feel the vibrations in my chest, you know, the whole house, and you couldn’t get away from it.

* * *

A. Yes, I could feel a thumping, thump, thump, thump, like it was thumping in my chest. It was extremely loud.”

Since 1985, Maple Lane Farms had been using their parcels to operate the farm as well as other things such as a pumpkin patch and corn maze in the fall. However, in 2000 they founded the Strawberry Jam Festival, a two day music festival held on their property, which lead to activities on the farm such as amplified musical performances, helicopter rides, and excessive ATV use. Shortly thereafter, the neighbors began to complain that the noise, bright lights, traffic and garbage was harming their health, comfort and property values. A neighbor sued the farm owner seeking to stop the activities on the property as a violation of zoning; specifically that these activities did not constitute a farming operation and thus the farm was not exempt from zoning requirements.

Under the Tennessee Right to Farm Act, Tenn. Code Ann. §§ 43-26-101 et seq. a farming operation is presumed neither to be a public or private nuisance. However, it is a rebuttable presumption that such farm operations are not nuisances unless a preponderance of evidence demonstrates that the operations do not conform to accepted agricultural practices. The Act also notes that a major point of it is to protect pre-existing farming activities from nuisance claims by newly arrived neighbors.

In a fairly broad approach to agricultural zoning and the Tennessee Right to Farm Act, the Court of Appeals held that the activities of Maple Lane Farms met the definition of “agritourism” and that these activities existed before the neighbor purchased her property. Shore v. Maple Lane Farms, LLC. No. E2011-00158-COA-R3-CV (Tenn. Ct. App. Apr. 11, 2012).

On August 16, 2012, the Tennessee Supreme Court granted permission for appeal. I would hazard a guess that the Supreme Court will take a more conservative approach here. Regardless, the opinion will prove to be an important one as this is an area of zoning and land use which needs some attention.

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