Tangible personal property (TPP) taxes are confusing, starting with their name. Even in the policy community, they are often poorly understood. They might be recognized as taxes on property that can be touched or moved, perhaps with some knowledge that the value of such property depreciates over time. In my experience, though, that’s often about the extent of even highly informed people’s knowledge of TPP taxes, unless they have to deal with them.
Because I have a forthcoming paper dealing with TPP taxes as they apply to data centers and other large, capital-intensive facilities, this seemed like an opportune moment to provide a short primer on how these taxes work more generally, and why they matter.
Defining Tangible Personal Property
The definition of personal property is downstream of real property. States often simply define personal property as any property that is not real property. Thus, everything turns on what’s included in real property: land and structures and, typically, fixtures.
In most states, anything that is permanently installed and functionally immovable without destroying it or the real property (including buildings) to which it is affixed counts as a fixture and thus represents real property. Sometimes fixtures are described as any asset that is “bolted down,” though that’s imprecise, because if an asset can be unattached and relocated, it’s probably not a fixture.
Personal property is what’s left after land plus structures and fixtures (improvements). It is divided into intangible (almost always exempt—think stocks, bank accounts, trademarks, etc.) and tangible personal property. Texas’s definition of tangible personal property is representative: “personal property that can be seen, weighed, measured, felt, or otherwise perceived by the senses.”
Machinery and equipment are classic examples, but the definition reaches all non-realty physical property, down to the paper plates in the office break room. Historically, household personal property (furniture, the silverware, etc.) was taxed as well, but states exempted such property—and usually vehicles as well—a long time ago. Most states likewise exempt inventory being held for sale, but unfortunately that’s not always the case.
Valuing Tangible Personal Property
Tangible personal property is assessed based on its current value, which is a depreciated fraction of its value new (which can be defined several ways). As with real property, there are multiple possible assessment methods, including sales comparison and income capitalization, though by far the most common approach is cost basis, which is simpler and more administrable. The other approaches are typically only relevant as alternative methods in valuation disputes.
Businesses must report the acquisition costs of all tangible personal property, but acquisition cost is not always the cost basis for tax calculations. All tangible personal property is depreciated based on years in service, but states use three different systems for establishing the value to be depreciated:
1. Original cost. The most straightforward initial value, representing the asset’s original acquisition cost.
2. Replacement cost new. This represents the current cost of an equivalent replacement, accounting for changes in both price and quality. Imagine, for instance, that a piece of equipment is now twice as expensive but can perform four times the work. Replacement cost would be half of the original cost, representing the cost of the replacement share of new property.
3. Reproduction cost new. This is the real or estimated cost of reproducing the exact same asset now, even if no one is producing that asset anymore. For an outdated piece of technology, it asks what it would cost to produce the same outmoded technology today, though in practice, this is usually formula-driven, based on state-supplied trended costs.
State use of the above terminology varies. Some states use the term “replacement cost” but utilize a trended cost approach that is better described as reproduction cost. Using reproduction cost as the TPP cost basis is generally less favorable to taxpayers—and, I would argue, less accurate—than relying on original cost or replacement cost, as (1) it assumes that the cost of supplying the asset has risen, unlike original cost; and (2) it does not account for obsolescence relative to better equipment now on the market, unlike replacement cost.
Whatever method a state uses, that asset’s value must then be depreciated to reflect how far along the property is in its usable life. Different asset classes have different depreciation schedules: some long, some short; some declining almost linearly over many years, and others declining to a low residual floor after a few years. The residual percentage is usually referred to as the “percent good factor.”
Some assets experience little decline in utility until taken out of service. A piece of manufacturing equipment, for instance, might be equally productive in year one and year twenty, though eventually it will break down or require costly repairs. In areas where technology advances rapidly, by contrast, an asset might be functionally displaced by new tech in a few years, or it might degrade rapidly, losing productivity along the way.
States usually allow companies to seek reductions in appraised value by claiming obsolescence, but that relief can be difficult to obtain even where theoretically permitted under state law. It often requires litigation, rather than being incorporated into the ordinary appraisal process. Even with faster depreciation schedules, therefore, TPP taxes can easily overvalue the machinery and equipment of industries at the cutting edge of technology, science, and health innovation.
Reforming Tangible Personal Property Taxes
Tangible personal property taxes are a tax on capital investment. Taxes on mobile capital are particularly distortionary and economically harmful, which is why some states have eliminated TPP taxes. Even where they continue to exist, policymakers should ensure that depreciation schedules aren’t overly stingy, especially for rapidly obsolescing assets, and they might want to consider moving away from “reproduction cost new” valuation methods where those are used.
This is outside the scope of my forthcoming paper, which addresses TPP taxes on large, capital-intensive facilities, but states with TPP taxes should also consider de minimis exemptions that can take most taxpayers off the rolls at minimal revenue cost. Many small businesses have exceedingly little TPP; for them, compliance costs are a far greater issue than the actual tax bill. De minimis exemptions don’t address the greater problem of a tax on mobile capital, but they do eliminate what is functionally a nuisance tax for many sole proprietors and small business owners.
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