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SHC Half Moon Bay, LLC v. County of San Mateo

California Court of Appeals, First District, Fifth Division

May 22, 2014

SHC HALF MOON BAY, LLC, Plaintiff and Appellant,
COUNTY OF SAN MATEO, Defendant and Respondent.

Superior Court of the County of San Mateo, No. CIV499595, John W. Runde, Judge.

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Cahill, Davis & O’Neall, C. Stephen Davis, Cris K. O’Neall and Andrew W. Bodeau for Plaintiff and Appellant.

John C. Beiers, County Counsel and Rebecca M. Archer, Deputy County Counsel, for Defendant and Respondent.


Jones, P.J.

“[T]he California Constitution requires generally the assessment of property at ‘fair market value’... [A]ssessors have a constitutional mandate to tax all property at fair market value if not exempt under federal or state law.” (See Elk Hills Power, LLC v. Board of Equalization (2013) 57 Cal.4th 593, 606-607 [160 Cal.Rptr.3d 387, 304 P.3d 1052] (Elk Hills).) “Intangible assets and rights are exempt from taxation and... shall not enhance or be reflected in the value of taxable property.” (Rev. & Tax. Code, § 212, subd. (c).)[1] Section 110, subdivision (d) prevents the direct taxation of “intangible assets and rights relating to the going concern value of a

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business” and mandates the “value of intangibles that directly enhance that income stream cannot be subsumed in the valuation of taxable property (§ 110(d)(1)), and must be deducted... from an income stream analysis prior to taxation.”[2] (Elk Hills, supra, 57 Cal.4th at pp. 618-619.)

In Elk Hills, our high court clarified which intangible assets and rights have “a quantifiable fair market value that must be deducted from an income stream analysis prior to taxation” pursuant to sections 110 and 212. (Elk Hills, supra, 57 Cal.4th at p. 619.) As the court explained, “intangible assets like the goodwill of a business, customer base, and favorable franchise terms or operating contracts all make a direct contribution to the going concern value of the business as reflected in an income stream analysis” and have “a quantifiable fair market value that must be deducted from an income stream analysis prior to taxation.” (Id. at pp. 618, 619.)

This appeal arises from a dispute regarding the property tax assessment of the Ritz Carlton Half Moon Bay Hotel (the hotel or the property) and presents “the question of how to properly value taxable property, with associated intangible assets, at fair market value.” (Elk Hills, supra, 57 Cal.4th at p. 605.) Appellant SHC Half Moon Bay, LLC (SHC), the hotel’s owner, claims the assessment conducted by the San Mateo County Assessor (Assessor) and approved by the San Mateo County Assessment Appeals Board (the Board) erroneously inflated the value of the hotel by including $16, 850, 000 in nontaxable intangible assets. SHC’s principal contention is the variation of the income approach the Assessor used to assess the hotel violates California law by failing to identify and remove the value of intangible assets. Respondent County of San Mateo (the County) urges this court to uphold the assessment.

Applying a de novo standard of review, we conclude the income approach used by the Assessor and approved by the Board to assess the hotel violated California law because it “failed to attribute a portion of [the hotel’s] income stream to the enterprise activity that was directly attributable to the value of intangible assets and deduct that value prior to assessment.” (Elk Hills, supra, 57 Cal.4th at p. 618; see §§ 110, subd. (d), 212, subd. (c); Sky River LLC v. County of Kern (2013) 214 Cal.App.4th 720, 735 [154 Cal.Rptr.3d 353] (Sky River).)[3]

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Specifically, we conclude the income method at issue here violated section 110, subdivision (d) by failing to remove the value of the hotel’s workforce, the hotel’s leasehold interest in the employee parking lot, and the hotel’s agreement with the golf course operator prior to the assessment.


The four-star luxury hotel is located on approximately 14 acres of land “on the bluffs of the Pacific Coast” at 1 Miramontes Point Road in Half Moon Bay.[4] Constructed and opened in 2001, the hotel comprises five structures, including a six-story main building with 209 guest rooms, a “signature” restaurant, a “world class spa” and salon, a fitness center, and a lounge. “[T]hree adjacent bungalows” contain 52 additional guest rooms. The hotel also includes an executive conference center, tennis courts, a basketball court, a pool and jacuzzi, and a three-level parking structure. The hotel is “situated between two of the United States’ finest golf courses” and “[g]uests have full privileges at both courses.”

SHC purchased the hotel for $124, 350, 000 in 2004. The purchase price included real property, personal property (e.g., furniture, fixture and equipment), and intangible assets and rights. At the time of sale, the Ritz Carlton Hotel Company, LLC managed the fully-operational hotel pursuant to a long-term management agreement. In 2004, the Assessor assessed the hotel pursuant to Proposition 13 at its purchase price of $124, 350, 000 and deducted the value of personal property, for a total value of $116, 980, 000. The Assessor enrolled the hotel at its purchase price of $124, 350, 000 because the appraised value was within five percent of the purchase price. SHC timely paid the property taxes.

SHC’s Appeal to the Board

SHC challenged the 2004 property tax assessment, claiming it erroneously included the value of $16, 850, 000 in nontaxable intangible assets, specifically: (1) the hotel’s workforce; (2) the hotel’s leasehold interest in the employee parking lot; (3) the hotel’s agreement with the golf course operator; and (4) goodwill. SHC claimed the income approach was “not appropriate for California property tax purposes” because it failed to identify and exclude intangible assets.

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According to SHC, the proper method to exclude intangible assets from the assessment was not simply to deduct the hotel’s management and franchise fee, but to identify, value, and deduct specific categories of assets in accordance with Section 502 of the Assessors’ Handbook, which provides that “‘the deduction of [a] management fee from the income stream of a hotel does not recognize or remove the value attributable to the business enterprise that operates the hotel.’” (Bd. of Equalization, Assessors’ Handbook, Section 502; Advanced Appraisal (Dec. 1998) p. 162 (Assessors’ Handbook), fn. omitted.) SHC argued the Assessors’ Handbook is “completely at odds” with the Assessor’s appraisal and claimed the deduction of a management and franchise fee did not adequately remove intangible property from the assessment.

A SHC’s Valuation and Evidence

James A. Gavin, Director of Duff & Phelps, prepared a report allocating “relevant tangible and intangible assets of the [property] pursuant to the accounting and reporting requirements of Statement of Financial Accounting Standards, No. 141, Accounting for Business Combinations. . . . The intended use of the analysis [was] to provide an allocation of value... for financial reporting purposes.” Using the cost method, Gavin determined the value of the hotel’s tangible assets was $99, 500, 000, comprised of land value of $20, 100, 000 and $79, 400, 000 in building and site improvements. Gavin allocated $107, 500, 000 of the property’s purchase price to tangible assets. He allocated $16, 850, 000 to intangible assets and identified the following intangible assets and estimated their value: (1) the hotel’s assembled workforce ($1, 000, 000); (2) the hotel’s leasehold interest in the employee parking lot ($200, 000); (3) the hotel’s agreement with the golf course operator ($1, 500, 000); and (4) “goodwill” ($14, 150, 000).

At the Board hearing, Gavin testified as an expert for SHC and explained, among other things, how he calculated the $16, 850, 000 value of intangible property. He stated, “[t]he goodwill in this case is a residual. It is basically taking the purchase price and working your way through all the different elements and all the different... tangibles and intangibles to get down to what is left over.” Gavin explained how he calculated the $14, 150, 00 value of goodwill: “from an accounting perspective, ... there is some type of premium being paid or value being asserted to a property based on whether it is the flag [i.e., brand], whether it’s the location, whatever it might be. We think there’s something there. [¶] So essentially that’s how we got that [$14, 150, 000], because again it’s a residual with all the other numbers combined, and deducted off the purchase price.”

Gavin conceded the income method “is how the people in the marketplace that are trading hotels look at hotels” but urged the Board to value the hotel

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in accordance with the Assessors’ Handbook, which recommends intangible assets and rights be separately identified, valued, and deducted from the entire business enterprise as a going concern to arrive at the taxable value of the property.

B. The County’s Valuation and Evidence

The County claimed the deduction of the management and franchise fee pursuant to the income approach excluded the value of nontaxable intangible assets. It argued SHC’s appraisal applied a “controversial methodology that is not generally followed in the appraisal industry or by the Assessor’s Offices for valuing hotel real property.” As the County explained, SHC’s method “essentially places a per square foot dollar value on the land and improvements and subtracts that amount from the purchase price. What is left, [SHC] says, is its ‘intangible’ goodwill value, ” which it claims “cannot be taxed.” The County contended SHC’s “assumptions and methodology... do not reflect the realities of the hotel market. The method used by the Assessor (popularly known as the Rushmore Method) better recognizes those realities and is supported by the Appraisal institute.”[5] According to the County, the FASB 141 (Financial Accounting Stds. Bd., Statement of Financial Accounting Stds. No. 141) analysis is used “for purposes of financial reporting” not for “deciding the real property value.”

The Assessor employed the sales approach, the cost approach, and the income approach to value the hotel and determined the “income capitalization approach” provided “the most persuasive and supportable conclusions when valuing a lodging facility.” As the Assessor explained, “[w]e used the Rushmore approach to valuation which is considered to be the accepted and widely used method in the hospitality industry. Basically, the net operating income from a stabilized year is calculated by removing the income attributable to and the business/going concern. What is left is the income attributable to the land and improvements. This is then capitalized into an estimate of value.”

Using the income approach, the Assessor derived a stabilized income stream for the hotel and then estimated the ...

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