An appraiser is capitalizing a property's income. Annual property tax equals an effective tax rate multiplied by value, and the base capitalization rate does not include any tax component. When is it appropriate to add the effective tax rate to the base rate?
Correct Answer
A) When income is stated before property tax and not reduced by it.
Tax loading avoids double counting only when the rate and income bases match. If annual tax is the effective tax rate t times value V and is excluded from income I, V=I/(R+t), where R is the base rate. Taxes already reflected in a tax-loaded extracted rate must not be added again.
Why This Is the Correct Answer
Option A is correct because adding the effective tax rate to the base rate is appropriate when the pretax income being capitalized has not had the same property tax deducted. Value is then income ÷ (base rate + effective tax rate), and the tax is counted once through the rate rather than twice.
Why the Other Options Are Wrong
Option B: When the property has no property tax liability for the year.
Option B, when the property has no property tax liability for the year, gives no reason to load the rate. With no tax, the effective tax rate is zero and there is nothing to add.
Option C: When an assessment exceeds sale price, apart from the income model.
Option C, when an assessment exceeds sale price apart from the income model, is unrelated to how the rate is built. Tax loading depends on how income and the rate treat property tax, not on comparing an assessment with a sale price.
Option D: When adding investor income taxes to an unrelated gross multiplier.
Option D, adding investor income taxes to an unrelated gross multiplier, mixes up ad valorem property tax with investor income taxes and applies it to a different tool. Tax loading adds the property tax rate to a base overall rate used on pretax property income.
Deduct it or load it
Property tax is handled once: either subtract it from income or add it to the rate, not both and not neither.
How to use: Use this rule to decide whether a tax component belongs in the rate.
Exam Tip
Check how the income was defined before adding a tax component; double counting occurs when taxes are both deducted and loaded.
Common Mistakes to Avoid
- -Loading the rate when taxes were already deducted from income
- -Adding a tax component under a net lease where the tenant pays taxes
- -Confusing investor income taxes with property taxes
Concept Deep Dive
Analysis
This question tests property tax loading of a capitalization rate. When the property tax is modeled as a percentage of value and is not deducted from income, the tax rate is added to the base rate so the tax is accounted for once. The two must match: income excludes the tax deduction, and the base rate excludes the tax component.
Background Knowledge
In some valuation settings, property taxes depend on value, so they cannot be deducted as a fixed expense before value is known. Instead, a property tax component is added to the capitalization rate. If the income is under a net lease where the tenant pays taxes, or the tax is already deducted, no tax component is added.
Real-World Application
An appraiser valuing a property where the tax will be based on the concluded value leaves property tax out of the expense list. The appraiser adds the effective tax rate to the base overall rate and divides the pretax income by the combined rate.
More Income Approach Questions
Which model describes yield capitalization of property benefits?
An appraiser is valuing a duplex. A market survey of recent duplex sales reports prices at 10.8 times potential gross income, with stabilized vacancy and credit loss of 10% of PGI and no other income. The subject's rent schedule is unavailable, but the property manager's records show collected income of $54,000 a year, in line with market rent and the 10% market loss. What value is indicated?
The subject property is a fourplex with annual EGI of $72,000 and operating expenses of $28,800. Of those expenses, $18,000 is fixed and $10,800 varies in direct proportion to EGI. The owner's annual mortgage payments are $21,000. An appraiser projects that EGI will fall 10% because of higher vacancy. What is the projected NOI?
Annual NOI available for debt service is $168,000 and total annual mortgage principal and interest debt service is $120,000. What is NOI ÷ debt service?
Annual PGI is $250,000 and combined vacancy and collection loss is explicitly 12% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $360,000 and combined vacancy and collection loss is explicitly 8% of that same PGI base. There is no other income. What annual EGI remains?
Annual PGI is $640,000. Combined vacancy and collection loss is 6.25% of PGI. There is no other income. What EGI remains?
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A cash-equivalent comparable price is $720,000 and annual EGI is $90,000 on the specified comparable basis. What is price ÷ EGI?
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