On April 30, 2019, Tennessee Gov. Bill Lee signed into law Public Chapter No. 265 (Senate Bill No. 708 or “S.B. 708”), amending the provisions of Tenn. Code Ann. § 67-5-502 relating to the taxation of leasehold interests. Prior to this amendment, T.C.A. § 67-5-502(d) directed assessors of property to assess property taxes against any taxpayer’s interest in real property leased from a tax-exempt entity. Those leasehold property taxes are assessed based on the value of the taxable entity’s leasehold interest, which is calculated as the difference between the fair market rent for the leased property and the actual and imputed rent for the property.[1] S.B. 708 amended § 67-5-502(d) to preserve property tax abatements on property that is subject to a valid payment in lieu of tax (PILOT) agreement, one of the most common forms of economic development incentives used by local governments in Tennessee. This amendment will simplify the documentation of PILOT agreements in Tennessee, saving time and money on transaction and compliance costs for both companies and local communities.
Because Tennessee law requires that all property be subject to property tax unless it is owned by a tax-exempt entity, PILOT incentives are structured as sale-leaseback transactions between the company and a tax-exempt local governmental entity charged with furthering economic development, such as an industrial development corporation, housing authority or health, education and housing board. Typically, a company sells its property for which it has been granted a tax abatement to the governmental entity and the governmental entity leases the property back to the company and requires the company to make certain payments in lieu of property taxes, which are typically lower than the property taxes that would have been owed by the company in the absence of the PILOT arrangement.
Prior to the passage of S.B. 708, PILOT leases needed to include sufficient actual and imputed rent to offset the fair market rent for the property. To mitigate the risk of a leasehold tax assessment, most transactions were structured with the governmental entity issuing debt in the form of a note or bond for the purchase and improvement of the real property subject to the abatement. That note or bond would be made payable by the governmental authority to the company receiving the abatement, and instead of funding money to the governmental entity directly, the company would agree to advance the funds to itself for the acquisition and improvement of the property that was owned by the authority and leased to the company. The authority would then direct the company, in its capacity as the lessee, to pay as rent all debt service due on the note or bond to the noteholder, thereby offsetting any fair market rental value that could result in a leasehold tax. Because the company serves as both the lender and the party responsible for repaying the debt, no money changes hands. Needless to say, this structure was unnecessarily complex, but the failure to follow it regularly could result in leasehold tax assessments that undercut the purpose of the PILOT transactions.
S.B. 708 provides that a lessee’s or a sublessee’s interest in real property owned by a tax exempt entity that “is the subject of a lawful agreement between a lessee and a local government, or instrumentality thereof, for payments in lieu of taxes” shall not be subject to a leasehold tax assessment, and that the “property shall be assessed solely to such governmental entity and shall be subject to all applicable exemptions.” This new exemption from leasehold taxation for property subject to PILOT agreements for real property applies to all PILOT leases entered into on or after April 30, 2019. PILOT leases entered into before that date are potentially still subject to leasehold taxation, meaning that those PILOT transactions would either need to include sufficient actual or imputed rent, or they would need to be amended in light of the new legislation to remove that requirement.
Since the debt obligations of industrial development corporations are subject to recordkeeping and reporting requirements, S.B. 708 eliminates this burden for PILOTs after its effective date. It also simplifies the company’s calculation of the rent payments under the PILOT lease that must be reported each year to the State Board of Equalization and the County Assessor of Property.
[1] Tenn. Code Ann. § 67-5-605.
