In re Custom Distribution Services, Inc.

95-37206, 95-3218, 1997 WL 795825 (U.S. Bankr. Ct. D. N.J. 1997)
  • Opinion Date: December 17, 1997

BANKRUPTCY; TAX APPEALS—Absent a prior determination by another judicial body, the Bankruptcy Court may fully determine issues of property tax liability. Environmental contamination may be used as a basis for reduction of a property’s value, based upon its effect on future income and the “stigma” of pollution.

A debtor in possession owning contaminated property brought an action to reduce the property tax as determined by the Tax Assessor of the City of Perth Amboy. Although there is a presumption of correctness of municipal tax assessments, a taxpayer can rebut such a presumption by showing a different valuation than that asserted by the municipality. The Bankruptcy Court asserted its jurisdiction pursuant to Section 505(a) of the Bankruptcy Code and stated that it may fully determine all issues of tax liability because there had been no prior determination by any state or judicial body. In making a tax determination, a court has to apply the substantive laws of the state where the property is located.

The Court found that New Jersey law requires the “true value” standard to be applied when assessing real estate. While not expressly defined by the legislature, state courts have accepted any of three following methods of valuation: the cost approach, the sales comparison (or market data) approach, and the income capitalization approach. The cost approach estimates the value of the property as if vacant and available to be put to its highest and best use. The sales comparison approach estimates fair market value by comparing the subject property to similar properties. The income capitalization approach analyzes a property’s capacity to generate future monetary benefits and converts them into present value. The City primarily used the income capitalization approach while the debtor-in possession used a hybrid of both the income capitalization and sales comparison approaches. As a result, the debtor-in-possession gave far greater weight to the contamination located on the property. The debtor argued that the Court must consider the full effect of cleanup costs as well as the stigma of contaminated property, while the City asserted that a reduction for stigma is rare. The Court stated that contaminated property presents a special problem because of the absence of adequate market data, and found that courts have often determined the “true value” of contaminated property.

The Bankruptcy Court held that the income capitalization approach would yield the most accurate assessment of true value, and rejected much of the “creative appraisal technique” used by the debtor’s appraiser. Taking some figures from the City and some from the debtor, the Court arrived at a figure it called “gross income capitalized.” The Court then reduced this figure in equal amounts annually over a ten year period to account for the reduced income that resulted (and was to result in the future) from the contamination. Finally, the Court found that stigma, although an ephemeral concept, should be calculated and used to further reduce the value of the land because contamination would surely affect rental income, occupancy, and expenses. This calculation was based on factors such as the severity and duration of the contamination, its effect on humans and wildlife, and the level of fear that the contaminants generate. The Court adopted the debtor’s figure that a 20% reduction in the value of the property was an appropriate estimation of stigma. Regarding the vacant land on the property, the Court stated that the City did not meet its burden of proving economic feasibility, and that environmental clean-up must be concluded before determining whether this “excess land” (land marketable independent of the parcel’s primary use) should be included in the tax assessment. The Bankruptcy Court assessed the value of the property at more than $2,000,000 less than the City’s valuation, and about $500,000 more than the debtor’s appraisal.