What is Tax Increment Financing (TIF)?

March 25, 2011 in TIF

Tax Increment Financing (TIF) is defined as the ability to capture and use most of the increased local property tax revenues from new development within a defined geographic area for a defined period of time without approval of the other taxing jurisdictions. It is a tool that cities, counties, economic development authorities (EDAs), port authorities, and housing and redevelopment agencies (HRAs) can use to spur private development.

There are four main reasons for using TIF:

  • Redevelopment of substandard or obsolete buildings, such as revitalizing a downtown area or former industrial site
  • Provide affordable housing, including rental or owner occupied housing for low to moderate income persons
  • Create jobs and new tax base, such as develop an industrial park or other manufacturing facilities
  • Clean-up environmental issues, such as  remediating contamination in brownfield areas

Here’s an example of how TIF works. After a TIF district is established, the Authority collects a portion of the new taxes generated by the development and uses them to pay for specific development costs. The taxes being paid at the time of the establishment of the district continue to be distributed to the city, county, and school district, as done prior to the establishment of the TIF district.

Now assume a blighted piece of property is paying $5,000 in property taxes in 2011.  Let’s also assume a new business wants to relocate on this piece of property and projects paying total local property taxes of $50,000 after construction is complete.  The community could reimburse the business the incremental taxes, or $45,000 per year, to help offset the costs of demolition and environmental remediation

Only a portion of the increase in taxes will be captured as increment and used for the project. Tax increment does not capture the base (existing) taxes, State commercial/industrial property taxes, or market value based property taxes.

It is important to note that the development will pay the same amount of taxes it would if it were not in a TIF district; TIF is not a reduction in taxes. The increase in taxes is being redirected to pay for eligible development expenses.

The maximum amount of time the increased taxes are redirected to the project varies from 9 years to 26 years, depending upon the type of district and depending upon the community’s TIF policies.

One of the most important concepts in TIF is the “but for” test.  A community must believe that the project would not have gone forward but for or without the use of TIF.  There are a variety of ways to demonstrate the need for TIF, including a thorough review of the project’s finances, comparable land prices, and/or extraordinary development costs.

Declining Values and “Frozen” Tax Rates for TIF Districts

March 22, 2011 in TIF

The National Association of Realtors released its monthly data on existing home sales yesterday.  If you have never spent any time looking at the details of the reports, spending a few moments on the NAR website is worthwhile.  One chart in this month’s report shows the median home values by major metropolitan markets.  The Minneapolis/St. Paul region is down from $159,000 in February, 2010 to $142,500 one year later.

This points to continuing slides in the valuations for property tax purposes and higher tax rates just to keep the same level of income for local governments.  TIF districts will also continue to see lower income if values slide and if you have a TIF district that is near its maximum or “frozen” tax rate.  All newer districts have a tax rate that is capped based upon the tax year in which authority requested certification of the district.  If you are projecting future increment steams, knowing the maximum tax rate will provide more accurate number.

How Do You Establish a TIF District?

March 17, 2011 in TIF

How does one know what kind of tax increment district to establish?  It’s easier than you think. Although there are pages in the law defining different types of districts, they all relate to two sets of facts:  What is on the site now, and what is going to be developed.

Tax increment is a financing tool to assist communities in redeveloping aging parts of their community, clearing obsolete and substandard buildings and reconfiguring parcels for new development.  Therefore, several types of districts are determined by current site conditions.  How much of the site is improved with buildings, parking lots, and roads? How many buildings and how many of them are substandard?

The general rule of thumb is that the worse the existing site conditions are, the longer you can collect increment. The two most common districts that qualify based on site conditions are the Redevelopment District, which has a 26 year term and more than 50% of the buildings are considered to be substandard, and the Renewal and Renovation District which has a 16 year term and more than 20% of the buildings are considered to be substandard.

In addition, Tax increment is a financing tool to assist in providing affordable housing and the development of manufacturing facilities. Thus we have two types of districts – Housing and Economic Development districts – that qualify based on what’s being built.

Housing Districts have a 26 year term and can be used to assist affordable owner-occupied and rental housing developments.  Economic Development Districts have a 9 year term, and can be used to assist manufacturing, tourism facilities, and call centers.

For more detail on the different kinds of district, check out our future blog posts.

You Win Some, You Lose Some

March 14, 2011 in TIF

As the legislative session plugs along it seems it is an on-going battle of you win some, you lose some, and then you wait to see if you really lost.  Back in January, a bill was introduced in both the House (HF195) and Senate (SF205) to extend the temporary TIF pooling authority under the JOBS bill that was enacted during the 2010 legislative session.  The extension would go until December 31, 2013 and would allow cities to continue to pool some of their TIF district cash balances to projects in order to stimulate private construction.

This past Saturday, the House Property Tax Committee released its property tax section of the omnibus tax bill and did not include this provision.  Essentially, there were two major opponents, Representative Ann Lenczewski (Bloomington and former chair of the House Tax Committee) and Rep. Dianne Loffler (Minneapolis). It seems that some of their concern was due to cities using TIF for housing projects and in particular, assisted living facilities.

Unfortunately, it seems the only developments getting financed and constructed these days are multi-family rental projects, including assisted living facilities.  Many communities have projects they were hoping to see developed if the legislative deadline was extended.

We will have to wait and see if the Senate includes the TIF extension in its version of the omnibus tax bill and then see what happens from there.  In the meantime, contact your local legislators if this is a tool your community needs to get some projects done.

Budgets within TIF Plans

March 10, 2011 in TIF

TIF Plans – those documents collecting dust on the shelves – contain useful little gems of information you can use to administer your tax increment districts.  Most importantly, the TIF Plan contains a maximum budget of how much increment you may collect, and how it will be spent.  The budget is prepared in advance of the project and, as with all budgets, needs amending from time to time to keep pace with changing development.

There are two ways to amend a TIF budget – an administrative amendment which is needed if you are staying within the original, maximum budget amount.  This amendment is adopted by the TIF authority governing board (HRA, EDA or Council) via a resolution and there is no public hearing required.  The second is a budget modification which is needed if you are increasing the budget above the maximum originally set.  This process is the same as creating a new TIF district and requires a 30 day notice to the county and school district for fiscal implications, review by Planning Commission and a public hearing.

Here are three budget tips:

  • You can move costs between line items in your project budget, so long as you do not exceed the total budget.  There are two key exceptions: bonded indebtedness and interest. To increase principal expense you need a full budget modification.  Click here to read more about the discussion of project costs in the Office of the State Auditor’s (OSA) newsletter.
  • The TIF Plan budget limits the amount of increment you can collect and increment in excess of the authorized budget must be returned to the County. Review your TIF balances annually against the budget in the plan to make sure you are within your original budget.  If it looks like you may go over, you will have to amend the TIF Plan budget as discussed above.
  • Review your budget prior to decertification to make sure you won’t have to pay back any increment.  No retroactive budget changes can be made following decertification.

Property Tax Freeze Bill Moving in House

March 9, 2011 in TIF

A bill is moving in the Minnesota House that would freeze city, county, towns and special district’s tax levies for next year. HF 481 is sponsored by Local and Property Taxes Chair Representative Linda Runbeck.  This bill would restrict increases in both operating and debt levies for local governments for taxes payable in 2012 and 2013 unless the bonds were issued or the projects contracted for by June 1, 2011.  Special districts defined in Minnesota Statutes, Section 275.066 and include HRAs, EDAs, transit agencies, etc.

At this time, it does not appear that TIF would be limited by this bill.  Tax increment financing payments are not included in a city or county property tax levy.  This type of freeze would be new territory for Minnesota.

However, any new property tax abatements under Chapter 469 would likely run into trouble if the freeze occurs.

MinnPost has a few comments from the author in a story from last week.  The League of MN Cities also added a page with its advice on the bill.

Check for Property Tax Petitions Before You Finalize TIF Payments

March 3, 2011 in TIF

Property taxes cannot be appealed, but the market value of a property can.  A tax court petition is a method of appealing your market value and in today’s economic environment, the number of tax court petitions is increasing.  Property owners who have seen their property’s market value fall, but not their taxes, are trying to do something about it.  More owners are challenging market values they believe don’t reflect the depressed state of the real estate market.

The Minnesota Tax Court is part of the State executive branch and was created under Minnesota Statute, Section 271.01 to settle disputes relating to Minnesota tax laws.  Minnesota Statutes Chapter 278 lays out the statutory requirements for filing a petition.  A couple of key points to know: all petitions must be filed by April 30th of the year the taxes are due AND the property taxes must be paid in full (unless you have an agreement to the contrary with the County).

Resolutions to pending tax court petitions can take well over a year.  The timing of when the petition is dismissed, settled, or granted, along with the administrative process for your county, will impact the cash flow to your TIF district.  Because property taxes need to be paid in full for a petition to be considered, the TIF district would receive a full year’s TIF payment that could be subsequently reduced if a reduction in market value is awarded.

Remember, it may take a year or more before a petition is settled or granted.  If the petition request is granted, the new market value will result in a reduction in property taxes due, often retroactively.  This will result in a refund to the property owner, which the County will deduct from the TIF district with the next tax settlement (M.S 278.12).

For example, let’s assume a TIF district has one parcel in it and the annual TIF generated is $50,000.   Let’s also assume a petition is filed for a reduction in value for taxes payable 2008, 2009 and 2010, but not decided until the end of 2011.  Finally, let’s also assume the decision results in $20,000 of tax total refund annually for those three years, or a total of $60,000.

This reduction in tax increment should result in a reduction in the payment to the developer on their next scheduled payment date.  Things get complicated if the amount refunded under the tax petition is more than the amount of increment received in your tax settlement and due to the developer.  (This can happen if there are petitions for multiple years.)   In our example above, the $60,000 refund is more than the annual TIF of $50,000.   In that case, the County may take the remaining $10,000 refund from other City funds, if there is inadequate funds in that particular TIF District.  This means the developer would receive no payment in that year and the payment in the following year would need to be reduced by $10,000 accordingly, in order to make the city whole.

If the TIF district has an outstanding bond, a reduction in the tax increment can have a significant impact on the bond payment.  If the TIF district does not have funds on hand in 2012 in our example above when the TIF is reduced to make up the difference, the City will need to find resources from other funds (perhaps in the form of an Interfund Loan, as discussed in a previous blog). In addition, the new reduced valuation could have impacts on future bond payments as well.

A tax court petition which has been filed but hasn’t been resolved can be particularly troublesome if your TIF district is about to expire…or has expired.  How do you know how much is going to be refunded, if anything?  Unfortunately, no one knows for sure until it’s all said and done.  The best you can do is estimate.

That estimate is important because if your TIF district has expired, the OSA requires that all remaining funds be returned to the County within nine months of expiration.  Unfortunately, the petition and possible refund may not be completed by then.  Therefore you’ll need to know if the estimated refund is more or less than the amount of TIF left in the district.  Either way you will want to delay returning those TIF funds until the petition has been completed. Overall it is important for a city to keep an eye on their pending tax court petitions.  A list should be provided by the County Attorney (M.S. 272.71(a)(3)) of all parcels in a TIF district for which a petition has been filed.  If you are not getting this list, you should contact your county.

In addition, when drafting the Development Agreement you may want to consider discussing some of the following options with your TIF attorney:

  • Requiring notification of all petitions filed by the developer
  • Prohibit the developer from filing any petitions for the duration of the TIF Note or Bond
  • Include language for a Minimum Assessment Agreement in M.S. Seciton 469.177, subd. 8
  • Withhold all or a portion of the TIF payment until the petition has been completed
  • Include language for a tax deficiency payment by the developer if the amount of increment isn’t enough to pay outstanding bonds

Prognosis for the Real Estate Market….This Week

March 1, 2011 in TIF

Employment drives everything, many economists say.  Certainly employment drives real estate.  More workers means more office development.  More disposable income means more retail.  More stable income means more housing needs.  Tax increment financing only works if someone is building something new.

However, there is another dimension to real estate that relates to consumer confidence.  Should I buy a home if I am worried that I may lose money in the future?  The Wall Street Journal is not optimistic this week in a new article.

Due to demographic changes with one of the largest graduating high school classes and a lack of trust in the home-ownership investment, we continue to see rental housing as one of the most vibrant portions of the real estate market.  This includes all sectors of the rental market, affordable, senior, and general occupancy.  We are working on several projects underway or soon to be underway in the metro area and in Greater Minnesota.  A recent report in the Star Tribune confirms this local trend on a national scale.

The Underlying Complexity of TIF: The Property Tax System

February 24, 2011 in TIF

We try to keep people’s eyes from rolling in the back of their head when we talk about tax increment financing.  However, there are many forces fighting against us when we try to hold our audience’s attention, the number one being the Minnesota property tax system.  We have a very complex set of laws governing property taxes.  We will start with a general overview and a few basic terms.  Later posts will describe more complex property tax concepts.

One of the big hurdles to understanding the system is the terminology.  House Research has a list of several pieces that offer definitions and timelines. The property tax system changes periodically in Minnesota.  A Department of Revenue piece offers some timelines for those interested in the history.  Currently, there are several types of property taxes (and exemptions):

1.  Minnesota does not tax most machinery or other types of personal property.  The value that is subject to a property tax is for land and building only.

2. Beginning in 2001, the State began to levy a property tax that applies only against commercial/industrial property and cabin owners.  This tax can be as much as 20% to 30% of the total tax bill.  TIF does not capture the State property tax.

3.  Certain types of taxes, such as school district operating levies that have been approved by votes and older county/city building referenda votes, are taxes solely on the basis of market value.  These taxes are not captured in TIF districts and vary from 1% to 10% of a tax bill.

4.  Fiscal disparities is a tax base sharing program in the 7 county metro area and in the taconite tax area of northern Minnesota. Commercial/industrial properties contribute to fiscal disparities and, most often, TIF districts do not capture the fiscal disparities portion of the tax bill.  This can be another 20% to 30% of the business’ tax bill.

Properties in a TIF district do not pay any more or any less in property taxes than if they were not in a TIF district.  Even though TIF may show up as a line item in a tax bill for a homeowner, the taxes will not go down if the property is removed from the district.  The taxes are merely redistributed to the other taxing districts.

For a business in the metro area, the amount of TIF available can be a minority of the taxes paid.  For example, an actual project had the following breakdown of a proposed tax bill:

  • $185,000 Total Tax Bill
  • -$55,000 for the State Tax
  • -$50,000 for Fiscal Disparities
  • -$10,000 for Market Value Taxes
  • -$10,000 for the Base or Existing Taxes
  • =$60,000 of Tax Increment

Residential properties will potentially yield more in TIF as a percentage of total taxes as will non-metro commercial property.  However, it is often tough to explain to a business why they cannot receive much of the tax bill back to help with a blighted property acquisition.

Compact Development TIF Districts: A New Opportunity

February 17, 2011 in TIF

One of the more difficult parts of TIF is defining “blight”.  In Minnesota, to include a parcel in a 26 year redevelopment TIF district, blight is primarily defined as an area containing buildings and other improvements with at least 50% of the building as structurally substandard.  The TIF law  in M.S. Section 469.174, Subd. 10(c) gives guidance on blight by defining what a substandard building is not (rather than saying what it is).  A number of court cases have given less clarity to what types of property meet the legal standards rather than more clarity.  To avoid controversy, many cities and counties have utilized a renewal and renovation district which lessens the standard to 20% of the buildings as structurally substandard.

Other communities have pursued legislation to help with redevelopment of areas that do not contain structurally substandard buildings but are in need of denser development.  Denser development is seen as a positive by many organizations to reduce the need for costly sewer, water and road infrastructure, to promote and complement mass transit, and to reduce the cost of housing with a smaller footprint.  The Metropolitan Council often promotes this philosophy in its grants, its review of city comprehensive plans, and its Framework Plan.

In the 2010 State Jobs Bill, a new type of district was introduced to assist communities with increasing density.  Specifically, a new type of TIF district called a Compact Development District (CDD) requires no finding of blight.  The requirement is simply that the site has substantial improvements such as parking lots, infrastructure, buildings, etc.; contains commercial/industrial buildings now; and will increase the square footage of the commercial/industrial buildings by at least 3 times.

The benefit of a CDD is a 26 year term.  The 2010 legislation requires creation of these types of districts by June 30, 2012.  There is not deadline on when a building permit needs to be pulled, other than the typical four and five year rules in TIF.

The Legislature does not often offer new opportunities for cities and counties to utilize TIF without restrictions on future development.  A former car dealership or a closed drug store would be great sites to consider. A CDD is a great opportunity for a community to plan long-term for new development.  Housing can be included in a CDD, but the housing cannot count toward the square footage qualifications.  This slower real estate market gives communities time to thoughtfully consider key sites that could accommodate more compact development.