“30+ Year Tenants” may File for Property Tax Exemption, but Ohio Supreme Court Holds that Tenant’s Charitable Use is not Enough to Establish Exemption when Property Owner is For Profit Entity Leasing Property For Profit

“In this world nothing can be said to be certain, except death and taxes”- Benjamin Franklin

In Ohio (and other jurisdictions) there are exceptions to Mr. Franklin’s general rule.  Certain entities such as corporations and limited liability companies may live on for many years beyond the death of their officers and shareholder-members; and property used exclusively for charitable or public purposes, such as schools, churches, government buildings, hospitals, and public recreation areas may qualify as tax exempt. Colleges and universities, nature preserves, children’s homes and certain homes for the aged may also qualify. Which taxes are exempt? Owners of exempt properties do not pay any real property taxes, however, any special assessments such as sewer maintenance or street lighting must still be paid by the property owner. Tax exempt status will carry into future years, however the owner must re-apply if the use of the property changes or ownership is transferred.

As discussed last week in this Blog by my colleague Connie Carr in her article: Ohio Supreme Court re Analysis of Property Tax Exemption Under RC 5709.121, “when a property tax exemption is being considered based on the owner being a charity, it is not sufficient to show that the property owner is a 501(C)(3) tax exempt charitable institution as defined by the IRS. In Ohio, it must be shown that the ‘core activity’ of the institution qualifies as charitable for property tax purposes.”  Ms. Carr provides that “real property belonging to a charitable institution will be considered as exclusively used for charitable purposes by that institution if it (1) is used by such charitable institution for a charitable purpose or used under a lease, sublease or other contractual arrangement for charitable purposes, or (2) is made available by such institution under its direction and control and furthers or is incidental to its charitable purpose and is not intended to be for-profit.”

Before one can get an opportunity to argue whether or not their property is exclusively used for charitable purposes, however, they must first prove they are one of the parties entitled by statute to file for a tax exemption, and entitled by statute to receive one. This was the issue faced by the Ohio Supreme Court in the recent case of ShadoArt Prods., Inc. v. Testa, Slip Opinion No. 2016-Ohio-511.

In ShadoArt Prods., Inc. v. Testa, 503 South Front Street L.P. was a for-profit company, who leased its 30,000 Sq.Ft. building for a term of 30 years to appellant-tenant ShadoArt Productions, Inc. (“ShadoArt”), a 501 (c)(3) non-profit organization. In 2011, ShadoArt filed an application for exemption under Ohio Revised Code (“O.R.C.”) Sections 5709.12 and 5709.121. The tax commissioner (appellee) denied the request, and in 2014, the Ohio Board of Tax Appeals (“BTA”) affirmed the denial. In 2015, appellant appealed to the Ohio Supreme Court.

Had this case come before the court prior to 2008, it would have ended there with a quick dismissal. In fact, the application would have been rejected as tenants were not then eligible, by statute, to apply for tax exemption. In 2008, however, the Ohio General Assembly amended O.R.C. Section 5715.27 to expand the class of entities that may submit applications for various real-property-tax exemptions. (See 2008 Sub.H.B. 160), including tenants of real property with terms of 30 or more years.

So, because O.R.C. Section 5715.27 was amended to authorize tenants with terms of 30 years or more (and other parties) to file applications for exemption, they must also be entitled to receive exemption under O.R.C. Sections 5709.12 and 5709.121 (if they can prove the property is being exclusively used by them for the exempt purpose). Correct?

That was the appellant’s argument. ShadoArt reasoned that if it has standing to file an application under O.R.C. Section 5715.27, then it also must have the underlying legal right to exemption; otherwise, the 2008 amendment would be meaningless.

The Ohio Supreme Court, however, did not buy the appellant’s argument. It affirmed the BTA’s decision that held the opposite. Namely, while “ShadoArt did have standing to file an application for exemption under R.C. 5715.27… the applicable exemption statutes…. R.C. 5709.12 and R.C. 5709.121 still control a determination of whether the property itself is entitled to exemption,” and that regardless of ShadoArt’s use of the property, an exemption was not appropriate here  because the property “belonged to” 503 South Front Street, LP [a for profit entity, not ShadoArt, the 501(c)(3) tenant].

The operative word here is “belongs”. “O.R.C. Section 5709.121(A) states that if property “belong[s] to a charitable or educational institution,” then it ‘shall be considered as used exclusively for charitable or public purposes by such institution’ if it meets one of several requirements.” Appellant claimed the property belonged to Tenant by virtue of its 30 year lease, and it should then be entitled to prove its use as charitable. The Ohio Supreme Court refuted this argument by citing precedent (prior decisions), stating: “We have long held that “belonging to,” as used in R.C. 5709.12, means “owned by,” and accordingly, “it is the owner’s use of the property, not a lessee’s use that determines whether the property should be exempted.” In other words, “an entity that leases property to another must establish its charitable status based on the range of its own activities and may not rely upon the activities of a particular lessee.”

The result in ShadoArt Prods., Inc. v. Testa seems to carve out an exception from the Ohio Supreme Court’s dictum in Rural Health Collaborative of S. Ohio, Inc. v. Testa (the case discussed in Ms. Carr’s article) regarding lease-like arrangements not always resulting in a denial of a tax exemption application. Based upon the holding of ShadoArt Prods., Inc. v. Testa, a tenant who files a tax exemption application and tries to prove the property’s entitlement to the exemption based upon the tenant’s charitable use only will most certainly be denied.

Perhaps a simpler way to reconcile these cases is to say that generally speaking, (1) “a property may be exempt for charitable purposes, even if the owner is leasing the property, provided that both the lessor and lessee are charitable institutions,” and (2) a for-profit landlord who owns property and leases it to a tenant for profit cannot claim its tenant’s charitable use as its own, simply by virtue of leasing to a tenant who is using the property exclusively for charitable purposes. The only thing seems certain after analyzing all of these decisions is that there is little certainty in tax exemption cases in Ohio.

Ohio Supreme Court re Analysis of Property Tax Exemption Under RC 5709.121

One of the more confusing areas in the world of charitable use exemptions of real property from taxation in Ohio revolves around situations where the property is leased.  On February 16, 2016, the Ohio Supreme Court decided an appeal from the Board of Tax Appeals (the “BTA”) regarding its grant of an exemption from property tax under ORC 5709.121(A).

This case involved real property in Adams County, Ohio owned by appellee, the Rural Health Collaborative of Southern Ohio, Inc. (“Rural Health”), which was leased to Dialysis Clinic, Inc. (“DCI”) for purposes of operating a dialysis facility in rural Southern Ohio.  Rural Health applied for a tax exemption on the real property and was denied by the tax commissioner who relied primarily on an earlier Ohio Supreme Court decision, Dialysis Clinic, Inc. v. Levin, 127 Ohio St.3 215, 2010-Ohio-5071, 938 N.E.2^nd 329 (“Dialysis Clinic”). The BTA reversed, concluding that the property qualified under ORC 5709.121(A) because Rural Health itself qualified as a charitable institution.

The tax commissioner argued in its appeal that Rural Health did not qualify as a charitable institution and that the precedent set in the Dialysis Clinic decision prevents an exemption being granted under ORC 5709.121.

The Ohio Supreme Court update the BTA’s decision in part but vacated its decision and remanded back to the BTA to complete additional analysis under the ORC.

When a property tax exemption is being considered based on the owner being a charity, it is not sufficient to show that the property owner is a 501(C)(3) tax exempt charitable institution as defined by the IRS. In Ohio, it must be shown that the “core activity” of the institution qualifies as charitable for property tax purposes.  This determination is primarily an issue of fact so the Ohio Supreme Court will defer to the taxing authorities and refer their determination under an abuse-of-discretion standard. In this case, Rural Health has three members, all of whom are nonprofits in Southern Ohio. The BTA looked at the big picture of all of Rural Health’s activities in which the construction and leasing of the dialysis center was only one piece. The Ohio Supreme Court stated that the fact DCI’s lease generates revenue for Rural Health did not, in and of itself, prevent Rural Health from qualifying as a charitable institution, and it upheld the BTA’s determination as reasonable and lawful.

The Ohio Supreme Court the turned its attention to whether the BTA properly analyzed the exemption request under ORC 5707.121.  This provision provides that real property belonging to a charitable institution will be considered as exclusively used for charitable purposes by that institution if it (1) is used by such charitable institution for a charitable purpose or used under a lease, sublease or other contractual arrangement for charitable purposes, or (2) is made available by such institution under its direction and control and furthers or is incidental to its charitable purpose and is not intended to be for-profit.

The tax commissioner argued that the existence of the lease and other circumstances with DCI preclude a finding that Rural Health exercised ‘direction and control” over the use of the property which is required under ORC 5709.121(A)(2). The Ohio Supreme Court did not buy this argument as lease-like arrangements do not always result in a denial of the tax exemption.

However, when the BTA granted the tax exemption based upon the determination that the provision of dialysis services furthers or is incidental to Rural Health’s purposes in compliance with ORC 5709.121(A)(2), it skipped over the first half of that section. The Ohio Supreme Court found that the BTA failed to evaluate whether the “direction and control” half of that section was met. As a result it reversed the exemption and remanded the case back to the BTA to complete that evaluation.

The tax commissioner argued that it is impossible for the BTA to find in Rural Health’s favor with respect to the “direction and control” evaluation as the court’s decision in Dialysis Clinic would control and require a finding against Rural Health. The Ohio Supreme Court disagreed stating that the deference courts give to controlling precedent relates to legal principles not findings of fact and the additional evaluation required of BTA is a factual determination.

The takeaway from this case is to appreciate that the unique facts of each case matter. The evaluation of whether a property tax exemption should be granted or not is fact-specific and there often is no simple one-size-fits-all answer or shortcut that can be taken.
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Caveat (Property) Manager

In the “old days”, when one could get 10%+ in a money market, a real estate management fee of 4-6% on rents did not excite many folks in the real estate industry about jumping into the property management business.

Now that 1% is considered a “high rate of interest”, and the stock market is rather volatile, management fees (and real estate as an investment) are a lot more attractive.

Before you rush to form your “Property Management LLC” company, however, “caveat manager”.

In Ohio, subject to limited exceptions, property management companies must have a real estate broker's license.

While there is no specific Ohio statute governing property managers, Chapter 4735 of the Ohio Revised Code governing Real Estate Brokers is dispositive. Why? Because pursuant to ORC Section 4735.01 (A), there are a list of activities, that if performed for another party, require a real estate license, and a number of these activities (including leasing and renting) are key components of property management.

What property management activities performed for another party require a real estate license?

-Pursuant to ORC Section 4735.01 (A) (1), one who rents or leases, or negotiates the rental or leasing of any real estate must be licensed.

- Pursuant to ORC Section 4735.01 (A) (2), one who “offers, attempts, or agrees to negotiate the …. rental or leasing of any real estate” must be licensed.

-Pursuant to ORC Section 4735.01 (A) (5), one who “operates, manages, or rents, or offers or attempts to operate, manage, or rent, other than as custodian, caretaker, or janitor, any building or portions of buildings to the public as tenants must be licensed.

Also included in the list of activities typically performed by property managers that require a license are: advertising or holding oneself out as in the business of leasing, one who performs any acts directed at procuring tenants for a property and one who collects rental information for purposes of referring prospective tenants to a rental unit.

Are there any exceptions to the requirement that one engaged in property management activities have a broker's license?

- There is no requirement that a community association manager or condo association manager in Ohio hold a real estate broker's license.

- Property owners managing their own properties are exempt. Additionally, receivers or trustees in bankruptcy, or guardians, executors, administrators, trustees, assignees, commissioners, or others  under authority or appointment of, or incident to a proceeding in, any court ;or under any trust agreement, deed of trust, will, or other instrument creating a like bona-fide fiduciary obligation are exempt. Also, public officers while performing the officer's official duties, and attorneys at law in the performance of the attorney's duties are exempt.

- Companies/individuals performing custodial, caretaker, or janitor services only are exempt.

 -While a real estate salesperson cannot manage property in his/her own name, or in the name of a separate management company he/she has formed, generally, a salesperson working under a broker may engage in management activities (See also OAC Section 1301:5-5-07 summarizing what property management activities an unlicensed employee may or may not engage in with respect to residential real estate).

Are there specific property management rules required of brokers to follow?

Yes. The Ohio Association of Realtors “Property Management White Paper” (http://ohiorealtors.org/legal/topics/wpproperty-management-laws/pm-whitepaper/) is one of the best summary guides available, but as a general matter, such rules pertain to:

-Property Management Accounts (OAC Section 1301:5-5-11);

-Security Deposits (OAC Section 1301:5-5-11 (D); and

-Rules governing sales as well as management/leasing activities such as: Agreements (ORC Section 4735.55); Property Records (ORC 4735.18 (A)(24); Consumer Guide to Agency Relationships (ORC Section 4735.56) and Agency Disclosures (ORC Section 4735.58).

Ohio UCC Provision Re: Constructive Notice Applies to All Recorded Mortgages, Even With Defective Acknowledgement

On February 16, 2016, the Ohio Supreme Court decided In re Messer, Slip Opinion No 2016-Ohio-510, which addresses the application of ORC 1301.401 to recorded mortgages that were deficiently executed under ORC 5301.01.

This decision was issued at the request of U.S. Bankruptcy Court for the Southern District of Ohio, Eastern Division (the “Bankruptcy Court”), who asked the Ohio Supreme Court (the “Ohio Court”) determine whether ORC 1301.401, which provides that the recording of certain documents provides constructive notice, applies to all mortgages recorded in Ohio and whether 1301.401 provides constructive notice of a recorded mortgage that was deficiently executed under ORC 5301.01.

In this matter, Daren and Angela Messer (the “Messers”) took out a loan in 2007 which was secured by a mortgage. The notary acknowledgement was left blank bringing into doubt whether or not they executed the mortgage in front of a notary. The mortgage containing incomplete notary section was recorded with the Franklin Counter Recorder.  In 2013 the mortgage was assigned to JP Morgan Chase Bank (the “Bank”).

The Messers subsequently filed a Chapter 13 bankruptcy and commenced an adversary proceeding requested that the mortgage be avoided as defectively executed under ORC 5301.01. If successful, the Bank would have lost its secured position.

The Bankruptcy Court in this matter decided that the Ohio Court should make the determination on the application of 1301.401, which is part of Ohio’s Uniform Commercial Code (the “UCC”), to a recorded mortgage that is clearly defectively executed under ORC 5301.01.

ORC 5301,01 provides that a mortgage must be signed by the mortgagor and the execution must be acknowledged by the mortgagor in front of a judge or clerk of court in Ohio, or a county auditor, county engineer, notary public or mayor, who shall certify the acknowledgement and subscribe the official’s name to the certificate of the acknowledgement.

ORC 1301.401(B) provides that the recording with any county recorder of any document described in ORC 1301.401(A)(1) is constructive notice to the whole world the existence and contents of that document as a public record and of the transaction referred to in that public record. ORC 1301.401(C) further provides that any person contesting the validity or effectiveness of any transaction referred to in a public record is considered to have discovered that public record and any transaction referred to in the record as of the time that the record was first tendered to the county recorder for recordation.

The documents described in ORC 1301.401(A)(1) specifically includes documents referenced in ORC 317.08, which expressly references mortgages.

While the Messers argued that 1301.401 only applies to transactions governed by the UCC and shouldn’t apply to mortgages since mortgages are governed by Ohio contract law. The Court disagreed, finding that the statute’s clear language indicated that it applied to any document referenced in ORC 317.08, which included mortgages. Based on the express language in the statute, the Court held that ORC 1301.401 applies to all recorded mortgages.

The Court went on to disagree with the Messers other contentions and further held that the portion of ORC 1301.401 that states the act of recording provides constructive notice to the whole world of the existence and contents of the mortgage document is compatible with provisions of ORC 5301.01 and ORC 5301.23 and the rest of the Ohio Revised Code and the fact that it is part of the UCC and not ORC Chapter 5301 does not prevent it from applying to mortgages.

In conclusion, the Court has clarified that ORC 1301.401 applies to all recorded mortgages, and acts to provide constructive notice to the world of the existence and contents of a recorded mortgage even if it was deficiently executed under ORC 5301.01. This is a win for common sense.

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