Since the financial crises of the late 2000s, out-of-town developers and institutional funds have flooded Philadelphia to capitalize on real estate opportunities. However, few out-of-state developers knew about the city’s hefty and rather confusing School District Business Use and Occupancy tax—also known as “U&O.” This article takes a closer look that this tax and explores opportunities for you to ease your burden and focus on growth.
Who Gets Pegged With the Tax?
U&O is imposed on businesses who use or occupy real estate within the City of Philadelphia School District to engage in any business, trade, occupation, profession, vocation or any other commercial or industrial activity. The user is subject to the tax, but landlords and their rental agents collect it on a monthly basis from their tenants. While the tax is collected by the City, the Commissioner of Revenue administers the tax and the generated revenue is used to fund the school district.
Origins of the Use & Occupancy Tax.
U&O was birthed in an effort to shift more of the tax burden to commercial and industrial property, while adhering to the 1967 Pennsylvania Supreme Court decision Madway v. Board for the Assessment and Revision of Taxes. The ruling prohibited multi-rate taxation of different types of real estate within a jurisdiction, which is frequently practiced in other areas. Since U&O is not officially a real estate tax, it’s constitutionally permissible.
How the City Imposes this Tax.
For the fiscal year ended in June 2018, according to the Philadelphia Department of Revenue’s 2018 Annual Report, Use and Occupancy tax collections were $176 million. This represents 16% of collections for the school district. Use and Occupancy Tax collections increased by $37 million from FY17 to FY18, or 26.6%, largely due to rising property values. In the last ten years, Use and Occupancy Tax collections have increased 43% from $112.7 million to $175.6 million.
The tax is imposed at the rate of 1.21% of the assessed value of the property. The assessed value is determined by the Office of Property Assessment “OPA.” Since 2014, the OPA has been assessing properties based on their fair market value according to the City’s Fair Value Initiative. For years beginning July 1, 2015 and thereafter, there is a $165,300 exemption amount that is subtracted from the assessed value of the property actually used for business purposes. This exemption translates into a $2,000 annual exemption, or $167 per month or $500 per quarter. Where there are multiple tenants or businesses occupying a property, the exemption must be allocated equally among all the users.
How to Pay on Time.
The tax can be filed and paid electronically online through the City’s eFile/ePay site. Monthly filers must file and remit the tax by the 25th of each month. Some small filers can apply to the City to file annually instead of monthly. A 1% deduction may be taken as compensation for the expense of collecting and remitting the tax by the person who collects and timely remits the tax due. No commission is permitted for an owner of the property that uses the property for its own business.
Certain types of property usage are excluded from the tax, including:
- Use of the dwelling or principal place of residence of user or occupier
- Any use of the property subject to the Pennsylvania Hotel Occupancy Tax
- Service, Utility and Common areas
- Use or Occupancy for a nonbusiness purpose
- Vacant commercial properties, or portions of commercial properties that are not currently in business use
- Persons engaged in activities related to the Port of Philadelphia are also exempt
- Eligible taxpayers located in a Keystone Opportunity Zone will receive a credit against their use and occupancy tax
Any person exempt from real estate tax is also exempt from the U&O tax. For example, property leased to the government, schools, hospitals and religious organizations are exempt. To be excused from collecting tax from a nonprofit, a landlord must obtain a copy of the nonprofit’s Federal Exemption Notice. The landlord must submit this document with the first tax return filed after receiving it.
For each occupant, the tax is computed separately. In a multi-story commercial office building, the tax is based on the square footage occupied by each tenant. It is also prorated by the days of actual use or occupancy during the business year, defined as 360 days.
What is the Actual Value Initiative?
As noted above, The Philadelphia OPA is charged with providing fair and accurate property assessments.
The Actual Value Initiative (“AVI”) was implemented in Tax Year 2014 for the assessment of all real property, land and buildings in Philadelphia at their current market value. Market value reflects the approximate amount a property would sell for in today’s real estate market. The purpose of AVI has been to make sure that all values are assessed fairly and in compliance with state laws, statutes and industry standards. It ensures that properties of equal value get the same assessments.
For commercial properties, the OPA considers the income approach, market approach, and in some situations, cost approach, and utilizes the approach that is most appropriate based upon property type and use. It also considers the income and costs of operating the property to determine its value, or considers the cost of construction and land.
How You Can Minimize the Tax.
You may want to consider an appeal of the real estate tax assessment if the owner believes the assessed value is too high. Appeals are filed with the OPA noted above. You can search and compare property values through the City’s online property search application.
Secondly, only the actual space rented by a tenant is subject to tax. To compute the tax attributable to each tenant, take the number of square feet of floor space contained in any building or other structure exclusive of the number of square feet in service, utility and common areas. All such space other than service, utility and common areas is included in "square feet available for use or occupancy,” even though some or all of such space may be excludable from the numerator of the tax apportionment fraction (see Section 505 of the U&O regulations) because it is vacant or because its use may be specifically excluded from taxation. Building owners should work with the building engineers to determine the “square feet available for use or occupancy” to insure that tenants are not being overcharged.
November 2019 Update
In Duffield House LP v. City of Philadelphia–a case involving assessment appeals by approximately 700 owners and lessees of commercial and industrial properties in the City, the Judge held that the City of Philadelphia’s reassessments of commercial real property for the 2018 tax year violated the Uniformity Clause of the Pennsylvania Constitution, that the plaintiffs’ assessments must be stricken, and that the City must pay refunds to the plaintiffs (taxpayers that appealed their 2018 real estate tax assessments on or before October 2, 2017).
The City is expected to the appeal the case to the Commonwealth Court.
In the meantime owners who were part of the litigation and remitted Use and Occupancy tax based on the higher assessments should consider filing claims for refund of the U&O tax. Of course, if the owner is a landlord, any refund of this tax would go back to the businesses that were lessees of the property. Others who were not part of the litigation should consider appealing their 2020 real estate tax assessments which in turn would lower their U&O assessment.
Please contact Stuart Katz or your Friedman LLP adviser to assist with a review of your current or projected U&O liabilities and the accounting involved in allocating the tax among the tenants.