Tax Incentives: What Do Cities Offer?

The use of tax abatement between a private developer and a city with respect to a qualifying project has become a popular topic over the last several years as infill development in the Valley increases. In certain circumstances — when the arrangement occurs in a so-called single central business district of a city — the municipality may abate the government property lease excise tax for a period of up to eight years. This arrangement has become known as “GPLET” (Government Property Lease Excise Tax), which refers to the beneficial abatement period where no such excise tax is paid. Once the abatement period ends, the obligation to pay the excise tax is reinstated and continues for the life of the transaction.

Only a city can lawfully create a GPLET arrangement, including the abatement. The terms of the arrangement will be open for negotiation between the city and the proposed developer. For example, the GPLET abatement may be (substantially) less than eight years. Another issue is the different distributions of GPLET excise tax and property tax revenue. An example is school districts: Such negotiation may include a separate payment agreement to a school district to adjust for the impact of the GPLET. A further part of these discussions can include the imposition by the city of items, such as real property use restrictions or other covenants, that may or may not survive the termination of the GPLET arrangement and the conveyance of the property back to the owner.

The obvious primary benefit is the tax abatement. Unlike many states and other countries, Arizona does not have tax increment financing, or “TIF,” as a public subsidiary for redevelopment and similar projects. The primary vehicle in Arizona for a redevelopment project or infill is a GPLET.

Various controversies regarding GPLET arrangements have been around for some time. In June of 2010, substantial changes were made to the GPLET laws, creating an “old rate” and “new rate” for the per-square-foot GPLET excise tax. To oversimplify, the new rate carries an inflation factor not found in the old rate. Also, the city’s obligations in creating the GPLET have become more complex over time. In both 2010 and 2016, the Arizona State Legislature created more procedural rules, notification and study requirements for the city.

It can be important that developers check their city’s GPLET boundary, as a GPLET tax abatement cannot occur just anywhere in a city. The abatement may occur only for government property improvements located in a single central business district designated by that city.

Complications in the GPLET Transaction

Complexity of Paperwork — For the GPLET to occur in the single central business district, the land must be owned by the municipality for the entire term of the arrangement. That real property includes the applicable governmental property improvement (e.g., the structure, such as an office, warehouse or apartments) built by the developer. If the city is not the owner of the land, the property must be taken into ownership by the city through a deed and resulting development lease where the developer is the prime lessee. This arrangement is typically documented by a development agreement that outlines the terms, together with the development lease, between the city and the developer. While typically not an issue, the statute does have a second component for abatement: The government property improvement as constructed will increase the property’s value by at least 100 percent.

Lender Concerns — The construction and take out lenders will have an array of concerns not encountered in a typical fee ownership construction financing arrangement. Much like any ground lease transaction between private parties, there are three parties to the loan financing — the lender, the borrower/lessee and the city/lessor. There are, inevitably, adjustments or supplemental agreements that are needed to accommodate the loan. While the city and its lawyers are very knowledgeable in this area, the process may take a fair amount of time and is subject to a further overlay of things a city can or cannot do as a governmental agency, including limitations contained in the city’s charter with respect to leases, or the provisions of the city’s ordinance or resolution that created the GPLET for the particular transaction.

Nothing Lasts Forever — The excise tax arrangement must end at some point, with the property being conveyed immediately from the city to the then-”owner” in the manner outlined in the development lease and related development agreement. This unwinding process can be complicated. In 2015, an Arizona appeals court case demonstrated the complexity of the “reentry” of the property into private hands and the property tax laws by confirming an adverse tax result for an owner. Timing of this conveyance can be important.

Thomas C. Arendt is an attorney in the real estate department of law firm Jennings, Strouss & Salmon. He is experienced in acquisition and development, leasing, and real estate workouts and foreclosures. Arendt’s representation has included various ground-up developments and retail centers, as well as banks and lenders in deed of trust, and mezzanine projects. He is a Certified Real Estate Specialist with the Arizona State Bar Board of Legal Specialization and a member of the State Bar’s Real Estate Advisory Commission.