Real Estate Tax Escalations

January 31, 2018 | By Charles Botensten

Q: I am a real estate agent and I am working on a transaction where the landlord is including a real estate tax escalation provision in the lease.  What are some important issues that the tenant should be aware of regarding real estate tax escalation provisions?

A: A real estate tax escalation provision in a lease (the “Escalation Provision”) generally requires a tenant to pay all or a portion of a landlord’s real estate tax increases over a negotiated base tax period (the “Base Tax Year”). For example, the Escalation Provision may indicate that the tenant is responsible to pay for 50% of any real estate tax increase over the taxes for the Base Tax Year beginning July 1, 2014 and ending June 30, 2015.  Accordingly, if the real estate taxes for the Base Tax Year are $20,000 and the real estate taxes for the fiscal period beginning July 1, 2015 and ending June 30, 2016 increase to $30,000, the tenant would be responsible to pay the landlord $5,000 (50% of the $10,000 tax increase).

In negotiating an Escalation Provision, a tenant and tenant’s attorney should give due consideration to the following:

 

  1. In order to keep the escalation as small as possible, the tenant should require the landlord to contest the real estate taxes annually by way of a tax certiorari proceeding.  A tax certiorari proceeding is a legal process by which courts review the real estate tax assessment for a property and determine if the tax assessment is too high (and, if it is too high, the tax assessment is reduced).
     
  2. The tenant should attempt to secure language in the Escalation Provision that the original amount of taxes for the Base Tax Year will not be decreased in the event that the landlord receives a reduction in the Base Year taxes as a consequence of a successful tax certiorari proceeding.
     
  3. The landlord should be required to provide to the tenant authoritative documentation in support of the landlord’s request for a payment in accordance with the Escalation Provision (e.g., a copy of the calculation along with the Base Tax Year bill and the then current fiscal year tax bill).
     
  4. The tenant should have the right to object to the landlord’s calculation of the escalation. 
     
  5. Ideally, the Escalation Provision will provide that (i) the first escalation payment will occur no earlier than one (1) year from the lease commencement date and (ii) a tenant’s escalation payment(s) can be paid in monthly, quarterly or semi-annual installments.
     
  6. The definition of “real estate taxes” should include business improvement district charges (as opposed to the business improvement district charge being paid as a straight “pass-through”).
     
  7. The definition of “real estate taxes” should exclude any general corporation, unincorporated business, succession, gains or transfer tax levied on the landlord.  Similarly, any occupancy or commercial rent tax payable by virtue of all or a portion of the building or any taxes or other amounts payable on account of the operation of any tax incentive or abatement program applicable to the building (the benefits of which are not afforded to the tenant) should be excluded from the definition of “real estate taxes.

The Legal Line Question by:
Neil B. Garfinkel
REBNY Broker Counsel

Partner-in-charge of real estate and banking practices at Abrams Garfinkel Margolis Bergson, LLP