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California Supreme Court:
Hotel’s Property Tax Assessment to Include Intangible Assets
Majority Says Both ‘Key Money’ Investment by Management Company, City’s Assignment of Nightly Occupancy Fees Amount to Taxable Income on Real Property
By a MetNews Staff Writer
A divided California Supreme Court held yesterday that the property tax assessment for a hotel—which is generally calculated by estimating the present value of the owner’s future income stream without taking into account intangible assets derived from purely business activities—may include “key money” payments made by a management company vying for work and city subsidies in the form of the assignment of occupancy fees to the enterprise.
At issue is Revenue and Taxation Code §110 which provides that “[t]axable property may be assessed and valued by assuming the presence of intangible assets or rights necessary to put the taxable property to beneficial or productive use” but specifies that “[t]he value of intangible assets and rights relating to the going concern value of a business using taxable property shall not enhance or be reflected in the value of the taxable property.” Justice Joshua P. Groban authored the majority opinion, joined in by Chief Justice Patricia Guerrero and Justices Carol Corrigan and Martin J. Jenkins, finding that the occupancy tax assignment and the key money payment are not the kind of “intangible assets” that are statutorily required to be excluded from the evaluation. He wrote:
“[B]oth payments derive from a type of intangible asset that effectively enable the property itself—as opposed to the business operating the property—to generate more revenue.”
Dissenting, Justice Leondra Kruger, joined by Justice Kelli Evans, acknowledged that the question of “whether the payments enable the hotel to generate additional revenue as property or…as a business” presents “a tricky line to draw.” However, she said that she would “place both payments on the business side of the line.”
Also writing separately was Justice Goodwin H. Liu, who declared in a single paragraph opinion:
“I appreciate the well-reasoned opinions of my colleagues, which ably elucidate the contending views. In the end, I agree with today’s opinion that the occupancy tax payments are properly included in the hotel’s value for property tax purposes. But I would hold that the key money payments may not be included for substantially the reasons set forth by Justice Leondra Kruger….”
Property Tax Assessment
Los Angeles County declined to remove the two sources of revenue from its tax assessment of a downtown property, now operating as twin hotels managed by The Ritz-Carlton and JW Marriott. The property is owned Olympic and Georgia Partners LLC, which challenged the decision before the locality’s appeals board.
The occupancy tax assignment, which the parties agree is worth $80 million, was offered by the City of Los Angeles to incentivize the building of a hotel near the downtown convention center. The “key money” at issue was the transfer of a combined total of $36 million from The Ritz-Carlton and Marriott, which was paid in order to secure management contracts.
After the board ruled in favor of the county, Olympic sought review in the superior court. Following a bench trial, then-Los Angeles Superior Court Judge Malcolm Mackey (now deceased) agreed with the board as to the two revenue streams but remanded to allow the agency to deduct from the assessment certain other intangible assets, including food and beverage sales, and certain goodwill benefits.
In a divided opinion authored by Justice John Shepard Wiley Jr., Div. Eight of this district’s Court of Appeal reversed as to the occupancy tax subsidy and the “key money” transfer.
Yesterday’s opinion reverses as to Div. Eight’s findings relating to the occupancy tax and “key money” payments. The high court affirmed the remand, directing the board to exclude the other intangible assets.
Key Inquiry
Groban cited the 2013 decision by the court in Elk Hills Power v. Board of Equalization and said:
“The key inquiry…is not merely whether the occupancy tax and key money payments derive from intangible assets, but rather whether those forms of revenue represent income that is primarily attributable to enterprise activity or whether they constitute ‘income of the real property or on account of its beneficial use.’ ”
Applying those principles, he opined:
“The shared characteristic of the types of assets [found to be excludable] in Elk Hills is that they increase the value of the business operating on the taxable property without necessarily increasing the amount of income that the property itself is capable of generating.”
Pointing to franchise rights and revenue generated from the goodwill associated with a brand as the “paradigmatic example[s]” of the type of intangible assets that should not be accounted for in a property tax assessment, he wrote:
“Unlike franchise rights or customer goodwill, the Occupancy Tax Agreement….increases the amount of revenue generated by the use of the property as distinguished from that generated by operating a business on the property: Each time a guest stays at the hotel, the property will generate additional revenue in an amount that is equal to 14 percent of the nightly rental rate. The hotel will continue to generate that revenue for the property owner regardless of what business is operating the hotel or how well or poorly the business is being run. That is substantially different than an asset like customer goodwill, which allows the entity that is operating the property to generate more business (and more income) for reasons that are unrelated to the property itself.”
Categorical Rule Rejected
Rejecting the view set forth by Div. Eight that Elk Hills established “a categorical rule requiring the assessor to deduct any and all forms of revenue that derive from intangible contractual rights that are necessary to put the property to its productive use and are capable of valuation,” he concluded:
“[W]e hold that when, as here, a project came into existence as the result of contractual guarantees that enable the property to generate additional revenue that is unrelated to…enterprise activity…, the assessor may properly consider that additional revenue when conducting an income method valuation.”
As to the “key money” payments, the jurist characterized them as being like lease payments and remarked:
“The Assessor…presented undisputed evidence that…management companies offer key money to hotels that have certain desirable physical attributes, such as their location within ‘coveted markets,’ their overall size and scope or their perceived ‘quality’….Because the evidence showed that the $36 million key money payment was a market rate form of revenue that the owner of a desirable hotel would expect to receive in exchange for enabling a management company to put the property to beneficial use, the Assessor properly included that revenue in its income stream analysis.”
He added:
“[W]e view Olympic as deriving two distinct forms of value from the relationship embodied in the management agreement: revenue that Marriott paid to secure the right to brand the hotel and conduct its commercial management activities on the property (which may be considered when assessing the value of the property) and revenue derived from Marriott’s competent management of the property (which may not be considered when assessing the value of the property). Whatever value Olympic’s business might derive from Marriott’s ability to increase profits through its management skills is distinct from the key money….”
Kruger’s Dissent
“Kruger wrote:
Like the majority, I would affirm the Court of Appeal’s decision to remand the matter to the assessment appeals board to further consider the value of the…so-called enterprise assets. Unlike the majority, however, I would also affirm the Court of Appeal’s conclusion that the Los Angeles County Assessor was not permitted to include the two revenue streams at issue here…when assessing the hotel’s value for property tax purposes.”
Saying that “the majority concludes that the occupancy tax payments belong on the property side of the line” because they derive value from the use of the taxable property, she argued:
“[T]he observation is…incomplete, because it overlooks the underlying source of the obligation to pay over the money: the City’s commitment of financial assistance to the hotel project as an incentive to develop and operate the hotel, using taxes that are owed to the City. As I see it, the City’s commitment to provide financial assistance for the development and operation of the hotel is attributable to Olympic’s business, not its property.”
As to the “key money” payments which she said “fall even more clearly” on the business side of the equation, the justice reasoned:
“Given the basic nature of the business relationship between hotel owner and hotel managers, I find it hard to view the key money as a payment for the privilege to occupy the property and ‘make beneficial use of the property.’…It is Olympic’s hotel business that runs its ‘commercial activities on the property,’ not Marriott’s hotel management business….Unlike in a typical landlord-tenant relationship, the stream of money due under the management agreement generally flows from Olympic to Marriott. One offsetting payment from the managers to the hotel owner, as a bargaining tool…does not represent income attributable to the hotel property, and it should not be included in the hotel’s valuation for property tax purposes.”
The case is Olympic and Georgia Partners LLC v. County of Los Angeles, 2025 S.O.S. 2536.
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