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Business property and local taxes: hypothetical taxes not allowed

Commercial real estate development often involves negotiations with local governments about services and tax payments.

If all goes well, these negotiations can yield the "win-win" arrangement that everyone seeks. Local governments get the benefit of development that might otherwise not have happened.

And businesses, for their part, not only get tax incentives. They get much-needed services.

Sometimes, however, an arrangement that seems to make sense at the time can lead to misunderstandings and litigation down the road. In this post, we will take note of a recent case of that type in Massachusetts.

The case involved the city of Marlborough and a business property owner who agreed in 1987 to make payments in lieu of taxes (PILOT).

The property in question was situated partly in Marlborough and partly in Southborough. The property owner at the time of the 1987 transaction negotiated a PILOT deal with Marlborough, seeking access to Marlborough's sewer system. Southborough did not have such a system.

Eventually, however, the property changed hands without the PILOT contract being properly recorded. The company that is the current owner of the property challenged the agreement and claimed that payments to Marlborough were no longer required.

Negotiations between the company and the city ensued.

The city contended that the 1987 agreement was a valid PILOT and threatened to withdraw sewer service. But the company countered that it was not properly structured and was functioning as an illegal real estate tax payment or user fee.

The company has prevailed so far in the litigation that began when negotiations broke down.

In a recent ruling, a federal judge did not accept the argument that a valid PILOT agreement could be based on taxes that would be owed if the building was fully present in Marlborough. There is no such thing, the judge said, as hypothetical taxes.

The case stands as a reminder that transactions involving business property and local taxes have to be structured with care.

Source: Marlborough Wicked Local, "Judge tells Marlborough: 'In lietu of taxes' payments were 'illegal'," May 9, 2014

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