Shining Light on the ‘Dark Stores’ Controversy

As a tax lawyer, I must say that it is not often that the valuation of real property generates much interest, let alone controversy, in the public sphere. Yet, the recent decisions by Michigan Tax Tribunal have done precisely that. At issue is a rather prosaic question of how to value “Big Box” stores, such as Target, Lowe’s, or Meijer, for local property tax purposes.

Before discussing the “Dark Store” methodology for valuation of such stores, we need to understand why it matters. According to the 2015 Michigan Association of County Treasurers (admittedly not an impartial observer), local units of government have refunded $75 million to “Big Box” stores since the Michigan courts have adopted the “Dark Store” methodology. This means that local municipalities have been forced to either reduce basic public services or to shift the burden of paying for them to homeowners and to other businesses.

What is the “Dark Store” methodology? As any homeowner (or business person) who has ever challenged their property tax assessment knows, the property taxes are a function of the property value. The property value has traditionally been determined using one (or more) of the following three methods: Comparable Sales Approach, Cost Basis Approach, and Income Approach. As their names imply, the Comparable Sales Approach bases the property value on sales of similar (comparable) properties in the relevant area, the Cost Basis Approach looks at the cost of construction less depreciation, and the Income Approach considers the projected cash flow of the property discounted to the present time. Since the Income Approach is not implicated in this debate, it will not be discussed any further.

A good appraiser (and a good tax lawyer) will always argue for the approach that best suits the needs of their client (taxpayer or the assessor).   A good judge, on the other hand, will look at which of the three approaches most closely resembles fair market value. It should be noted that, at least in theory, no approach is definitively better than the others and each has its merits and shortcomings.

Historically, Michigan counties, according to their Association, valued “Big Box” stores on a Cost basis. This approach has the clear advantage of objectivity: the historical cost is a known fact as is the historical depreciation. It also has the clear disadvantage of being of little use for older properties that have been fully (or significantly) depreciated. For newer properties, on the other hand, it is likely to result in a fairly accurate valuation. This method is most suitable for facilities for which no market, an inadequate market, or a distorted market exists.

“Big Box” stores, of course, want the lowest valuation possible. And as repeat litigants who face the same issue in every municipality, they have every incentive to create a uniform system favorable to them. Having gone up against several tax-dodging Fortune 500 companies while at the Justice Department, I was not surprised that the “Big Box” stores found some high-priced attorneys who invented the “Dark Store” methodology. The “Dark Store” methodology is a variation of the Sales Approach. As I hope the reader recognizes, there is absolutely nothing wrong with the theory of the Sales Approach. But that approach is only as good as one’s selection of “similar” or “comparable” stores. The real coup was the “Big Box” stores’ ability to include as “comparables” those properties that are vacant or (“dark”). Compounding the unfairness is that many properties remained vacant because the “Big Box” stores have either refused to sell them to other retailers or imposed various deed restrictions on the properties. Both actions have the effect of reducing “comparable” values and, therefore, reducing the property values of active stores.

In reaction to an outpouring of complaints from townships, cities, and counties, Michigan House passed HB-5578 on June 8, 2016. The bill expressly directs the Michigan Tax Tribunal to, among other things, exclude from the list of “comparable” properties those properties that are subject to a deed restriction if that deed restriction “substantially impaired highest and best use” of the property. It also imposes a number of restrictions on the use of vacant properties in valuation. The result of these adjustments is to reduce the ability of “Big Box” stores to manipulate the property tax assessment process.

While the House passed this bill with overwhelming support (97-11), it is not known when (and whether) the Senate will take up this issue. It may, however, not matter in the long run. I noted from the outset that the “Dark Store” methodology was adopted by the Michigan Tax Tribunal in several decisions. On May 26, 2016, the Michigan Court of Appeals reversed the Tax Tribunal in one of those cases involving a Menard’s in Escanaba, sending a clear message that the “Dark Store” days may be numbered.

Jan M. Geht, JD, CPA, MST assists taxpayers resolve their civil and criminal tax disputes.  He is a shareholder with Bowerman, Bowden, Ford, Clulo & Luyt, P.C. in Traverse City.  Prior to moving to Traverse City, Mr. Geht worked for the Tax Division of the U.S. Department of Justice.