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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.

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