Sky River LLC v. Kern Cnty.

• Decision Date: 21 February 2013
• Docket Number: F063766
• Citation: 214 Cal.App.4th 720,154 Cal.Rptr.3d 353
• Court: California Court of Appeals Court of Appeals
• Parties: SKY RIVER LLC et al., Plaintiffs and Respondents, v. KERN COUNTY, Defendant and Appellant.

214 Cal.App.4th 720

154 Cal.Rptr.3d 353

SKY RIVER LLC et al., Plaintiffs and Respondents,

v.KERN COUNTY, Defendant and Appellant.

F063766

Court of Appeal, Fifth District, California.

Filed February 21, 2013

Reversed and remanded with directions.

See 9 Witkin, Summary of Cal. Law (10th ed. 2005) Taxation, § 214.

APPEAL from a judgment of the Superior Court of Kern County. Sidney P. Chapin, Judge. (Super. Ct. Nos. CV–269555 & CV–268774)

Theresa A. Goldner, County Counsel and Jerri S. Bradley, Deputy County Counsel, for Defendant and Appellant.

Gordon & Polland, Paul M. Gordon and Jonathan Polland for Plaintiffs and Respondents.

OPINION

HILL, P.J.

This is an appeal by Kern County from the trial court's judgment, which rejected the decision of the Kern County Assessment Appeals Board (board) upholding the county tax assessor's increased valuation of plaintiffs' business property and the resulting increased property tax. The county contends the trial court applied the wrong standard in reviewing the administrative decision; it contends application of the correct standard would have resulted in a judgment upholding the administrative decision because it was supported by substantial evidence. The county further asserts that the trial court erred when it admitted new evidence that was not presented to the board and when it determined the tax assessor used incorrect revenue figures in calculating the income stream on which the property value was based in one of the appraisals. We conclude the trial court applied the correct standard of review, properly admitted evidence at trial, and correctly rejected the county's revenue figures. Contrary to the trial court's judgment, however, the matter must be remanded to the board for further proceedings because factual questions remain.

FACTUAL AND PROCEDURAL BACKGROUND

Plaintiffs in these consolidated actions, Sky River LLC (Sky River) and Mojave 16/17/18 LLC (Mojave), are two related limited liability companies ¹ that own and operate wind farm electricity generation facilities in Kern County. They challenged the tax assessments of the Kern County tax assessor for plaintiffs' business property ² for 2006 and 2007. The property consisted of wind turbine generators and related equipment, used to generate and transmit electricity. Both plaintiffs paid the taxes and initiated administrative proceedings before the board to challenge the valuations of their property. The board held two hearings; it reviewed the complex calculations the tax assessor used in computing the tax and the alternative calculations proposed by plaintiffs, and found in favor of the county. The board approved the tax assessor's increased valuation of the property. Plaintiffs then filed actions in the superior court for a refund of a portion of the property taxes paid, again asserting that the tax assessor overvalued the property. The trial court found in favor of plaintiffs, concluding the tax assessor used a flawed methodology in calculating the value of the property, resulting in an inflated value and an overstated tax. It adopted the method of computation plaintiffs advocated and accepted the corrected figures they submitted. The trial court entered judgment setting out the corrected values for each plaintiff's property and ordering a refund of any excess tax paid. The county appeals from the judgment of the trial court.

DISCUSSION

I. Standard of Review

The initial issue presented by this appeal concerns the appropriate standard of review in the trial court. The county contends the board's decision was based on factual determinations; accordingly, the trial court should have deferred to the board's findings of fact and should have reviewed the decision only to ascertain whether it was supported by substantial evidence. Plaintiffs contend the material facts were undisputed and the issue was whether the tax assessor applied the proper methodology in calculating the value of the property, in accordance with applicable statutes and regulations. Plaintiffs assert this was an issue of law, which the trial court properly reviewed de novo. The correct standard of review depends upon the nature of the dispute before the trial court.

Property subject to taxation must be assessed at its full value, which is defined as its full cash value or fair market value. (Rev. & Tax.Code, §§ 110.5, 401.) “ ‘[F]ull cash value’ or ‘fair market value’ means the amount of cash or its equivalent that property would bring if exposed for sale in the open market under conditions in which neither buyer nor seller could take advantage of the exigencies of the other, and both the buyer and the seller have knowledge of all of the uses and purposes to which the property is adapted and for which it is capable of being used, and of the enforceable restrictions upon those uses and purposes.” (Rev. & Tax.Code, § 110, subd. (a).) There are three basic methods for calculating fair market value: (1) the comparative sales or market data method; (2) the reproduction or replacement cost method; and (3) the income method. (Cal.Code Regs., tit. 18, §§ 3, 4, 6, 8; Pacific Mutual Life Ins. Co. v. County of Orange (1985) 187 Cal.App.3d 1141, 1147, 232 Cal.Rptr. 233.) In this case, the parties agree the value of the property should be calculated by using the income method, which is described in California Code of Regulations, title 18, section 8 (Rule 8).³

The income approach seeks to determine “[t]he amount that investors would be willing to pay for the right to receive the income that the property would be expected to yield, with the risks attendant upon its receipt.” (Cal.Code Regs., tit. 18, § 3, subd. (e).) “Using the income approach, an appraiser values an income property by computing the present worth of a future income stream. This present worth depends upon the size, shape, and duration of the estimated stream and upon the capitalization rate at which future income is discounted to its present worth.” (Rule 8, subd. (b).) “ ‘The income method rests upon the assumption that in an open market a willing buyer of the property would pay a willing seller an amount approximately equal to the present value of the future income to be derived from the property.’ [Citation.] ... ‘ “The income approach may be called the capitalization method because capitalizing is the process of converting an income stream into a capital sum, i.e., value.” [Citations.]’ ” ( Freeport–McMoran Resource Partners v. County of Lake (1993) 12 Cal.App.4th 634, 642, 16 Cal.Rptr.2d 428 ( Freeport ).)

“ ‘The assessor capitalizes “the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt.” [Citation.]’ [Citations.]” ( Freeport, supra, 12 Cal.App.4th at p. 642, 16 Cal.Rptr.2d 428.) “The discount factor or capitalization rate which is applied reflects interest, the risk of no return or a lesser return of income, liquidity, investment management, taxes, and depreciation, where appropriate. [Citation.] Thus, a high-risk investment carries a proportionately higher capitalization rate.” ( Texaco Producing v. County of Kern (1998) 66 Cal.App.4th 1029, 1037, 78 Cal.Rptr.2d 433 ( Texaco ).) “Since a property's ‘full value’ must be determined by reference to the price it would bring on an open market, ‘[t]he net earnings to be capitalized ... are not those of the present owner of the property, but those that would be anticipated by a prospective purchaser.’ ” ( Freeport, at p. 642, 16 Cal.Rptr.2d 428.)

There are two means by which a capitalization rate may be developed. (Rule 8, subd. (g).) “The preferred method is to derive the rate from the market by ‘comparing the net incomes that could reasonably have been anticipated from recently sold comparable properties with their sales prices adjusted, if necessary, to cash equivalents....' [Citation.]” ( Texaco, supra, 66 Cal.App.4th at p. 1037, 78 Cal.Rptr.2d 433.) Alternatively, when there is a lack of comparable property sales, a “band-of-investment method” may be used: a discount rate is developed by “deriving a weighted average of the capitalization rates for debt and for equity capital appropriate to the California money markets.” (Rule 8, subd. (g)(2).) Using this method, also known as the weighted average cost of capital (WACC) method, the appraiser must “weight the rates for debt and equity capital by the respective amounts of such capital he deems most likely to be employed by prospective purchasers.” ( Ibid.) “This method is based on the premise that the yield rate is the weighted average of the return on the different portions of the investment, i.e., debt and equity. [Citation.]” ( Texaco, at p. 1038, 66 Cal.App.4th 1029.)

The income stream to be capitalized pursuant to Rule 8 is “the net return which a reasonably well informed owner and reasonably well informed buyers may anticipate on the valuation date that the taxable property ... will yield.” (Rule 8, subd. (c).) Net return is the difference between gross return and gross outgo; gross outgo does not include amortization, depreciation, property taxes, or income taxes. ( Ibid.) Because taxes are not excluded from net return, the income stream to be capitalized is before-tax. Accordingly, the discount rate used must also be before-tax. The discount rate computed pursuant to the WACC method, however, is an after-tax rate, which must be adjusted to a before-tax rate in order to apply it to the income stream. (SBE Assessors' Handbook (Dec. 1998) § 502, Advanced Appraisal, p. 98 & appen. A, p. 180 [as of Feb. 14, 2013].) This adjustment is made “by dividing the after-tax WACC by 1 minus the combined state and federal corporate income tax rate.” (SBE Assessors' Handbook, supra, § 502, appen. A, at p. 180.) The income tax rate to be used is “the combined federal and state marginal corporate income tax rate (i.e., the tax rate paid on each incremental dollar of income).” ( Id.,...