Municipalities use Payment in Lieu of Taxes (PILOTs) to encourage development of a project that might not otherwise be financially viable. If local officials determine that the redevelopment of a certain area would benefit the town, they can incentivize development in that area through the PILOT program which essentially gives the developer a break on property taxes. However, this option is sometimes a lightning rod for school districts that feel short changed when the PILOT payments are made.
Traditionally, a residential or commercial taxpayer is required to pay property taxes to the municipality in which it is located. In New Jersey, the property tax bill is generated by the municipality, but the taxes are collected on behalf of various taxing entities, predominantly the municipality, school district and county government. In addition, other smaller, less significant taxes (such as library or open space taxes) are also collected by the municipality. Following the receipt of the tax revenue, the municipality in turn pays the county and school district and other taxing entities their share. When a PILOT is used, the municipality essentially receives 95 percent of the revenue and the county government receives 5 percent. To a much lesser extent, school districts and other taxing entities do receive revenue from a PILOT classified property, but they might not realize it. This is because taxes are still collected on the land, and onlythe property improvements are exempt.
Knowledge is Power School districts should be educated about PILOTS and anticipate a strategy to be in the loop when negotiations are taking place. The structure of the PILOT payments is the result of a negotiation between the developer and the municipality. As mentioned earlier, only municipalities and counties are entitled to collect their respective portions of PILOT payments. The municipality collects 95 percent and the county collects 5 percent. School districts are not legally “entitled” to share in these payments, but that doesn’t mean that they are not permitted to participate. For certain redevelopment projects, school districts can endeavor to “get a seat at the table” to come to terms with the local leaders and to attempt to share in a portion of the payments. This is especially important if the new development generates children that will be enrolled in the school district.
How Does the PILOT Process Work? The PILOT payment is determined through a negotiation with the developer. The governing body can tailor the program to fit its needs, but the statute only allows a maximum tax relief of 30 years from completion of the project, or 35 years from the execution of the financial agreement. There are two types of PILOT structures, the Long-Term Tax Exemption Law (LTTE) and the Five-Year Tax Abatement Law.
If the developer uses the LTTE option, the agreement is structured in one of two ways: Not less than 10 percent of the project’s gross annual revenue would be paid; or, not less than 2 percent of the project costs would be paid annually. If the PILOT is based on the percentage of annual gross revenue, rental income as well as other fees paid by the tenant, such as insurance and parking amenities should also be considered when calculating the agreement. The agreement needs to be specific in these matters so that all appropriate revenue that is collected by the developer is defined. Likewise, if the percentage of project cost method is used, all associated costs must be captured in the calculation. These include the cost of land acquisition and preparation, surveying, legal, engineering and other professional fees as well as the fair-market value of direct labor, the cost of all construction materials and entrepreneurial profit.
The Five-Year Tax Abatement option is used for an area in need of rehabilitation. The first year is tax exempt; years two through five are phased in at 20/40/60/80 percent of otherwise conventional taxes.
The payments that the developer makes are called the Annual Service Charge (ASC). Both options are subject to annual minimum payments. Verification of the basis for the LTTE option payment (either 10 percent of gross annual revenue or 2 percent of project costs) is calculated periodically for accuracy. Additionally, after 15 years, there is a minimum step-up of traditional taxes paid. For example, if the PILOT is structured for 20 years, after 15 years, the payment would revert to 20/40/60/80 percent of traditional taxes until the 100 percent true level is reached.
The developer submits an application for long-term tax exemption that includes a financial pro-forma which details construction costs estimates, site plans etc. It is important that the municipality have financial and legal representation to negotiate a fair agreement. Municipal officials should evaluate the proposal and make reasonable assumptions of the economics of the project. These factors include determining the value of taxes that could be generated over the term of the PILOT if the property were assessed at the fair market value. Also, the full impact of the development should be considered. For example, if single-family homes are developed, will there be an increase in school enrollment in the school? If a high-rise building is constucted, do the local fire services have adequate equipment to protect the building or will additional equipment need to be purchased? If senior housing is built, will those residents need additional emergency services? An increase in any of these local services should be taken into consideration when negotiating a PILOT agreement.
What’s Important to Know While negotiating the terms of the PILOT with the developer, the municipality needs to determine the difference between the tax payment of the property with and without the PILOT. A thorough analysis should be completed to achieve the best outcome for the taxpayers.
As mentioned earlier, PILOT payments can be calculated based on gross annual revenue or as a percentage of total project cost. In either case, taxes are paid on the land portion of the property since the exemption is on improvements only. Therefore, a school district does receive some revenue for a property that is paying taxes through a PILOT agreement.
A property assessment is based on two factors: land and improvements. If the town completes a revaluation during the term of the PILOT agreement and the land portion of the property increases, the payment of taxes based on the land would increase. This increase will benefit the school district since land taxes are still collected and the school district will get its pro-rata share of the tax revenue. PILOT participants are required to submit annual financial audits to determine ASC and to insure compliance. However, this needs to be enforced. PILOT payments are made in accordance with the financial agreement and in quarterly installments according to the property tax payment schedule.
A developer can also request additional financial assistance from a municipality. For example, if environmental remediation is required or if infrastructure improvements are needed, the municipality can issue general obligation bonds to finance those improvements. If there is a demonstrated need, Special Redevelopment Area Bonds can also be issued. These bonds are secured by the municipality’s general obligation pledge or by PILOT payments in that the payments are used to repay the bonds. These scenarios require a significant commitment from the municipality and the costs and benefits should be evaluated.
Once the terms of the agreement are finalized, the law permits municipalities to adopt an enabling ordinance to implement a PILOT program. Once the PILOT has been negotiated, the terms of the agreement must be approved by the state Department of Community Affairs.
PILOT agreements are meant to spur the development of a property, or an area that is not otherwise generating its maximum contribution to a town’s tax base. The negotiation of the PILOT agreement should be a thorough and fair process. Because state laws do not require that the local school districts receive a direct portion of the PILOT, local officials should take the opportunity during the negotiating process to ensure that if the new property directly affects the school district, accommodations should be made to include the school district with compensation or appropriate credit.