How is business machinery that is still being built taxed in Kansas on January 1?

Plain-English summary

When a business builds a piece of machinery on site over several months, what is it on January 1 while it is still half-assembled? Kansas had two competing answers, and the answer mattered a great deal.

The directive spells out the stakes: "If the property is considered to be 'commercial and industrial machinery and equipment,' it is valued in accordance with the constitutional formula set forth in art. 11, § 1 of the Kansas Constitution for such property and it is assessed at 25%. If the property is not yet considered to be commercial and industrial machinery and equipment, then it is classified as 'other' personal property and it is value based upon its fair market value and it is assessed at 30%."

So the choice was between a formula-based value assessed at 25% and a market value assessed at 30%.

The Division came down on the machinery side. Its holding: such property "shall be listed at its retail cost when new and depreciation shall begin the first year the property is listed for taxation without regard to the stage of completion."

The authority is an Attorney General opinion, quoted in the directive: "commercial and industrial equipment that otherwise meets the criteria for classification as such does not become 'other' property to be valued at market and assessed at a different rate merely because it is not yet in operation." That opinion, A.G. Opinion #97-97, rested on "a common person's understanding of the term 'commercial and industrial machinery and equipment' set forth in art. 11, § 1 of the Kansas Constitution."

The directive instructs counties accordingly: value under A.G. Opinion #97-97 and the constitutional formula, construe "retail cost when new" consistently with the McGraw Fertilizer decision, and "assess such property at 25%."

The formula. Art. 11, § 1 "requires that commercial and industrial machinery and equipment be valued based upon its retail cost when new less straight-line depreciation over its economic life or a seven-year period, whichever is less."

Depreciation starts immediately. This is the practical heart of the directive, and it is explained by analogy. A new desk acquired in the midst of a year "is listed the immediately following January 1 st and it is allowed one year of depreciation the first year it is listed." The directive then applies that: "Similarly, here, when commercial and industrial machinery and equipment is constructed on site commencing in the midst of a year, it shall be listed the immediately following January 1st and it shall be allowed one year of depreciation the first year it is listed. The second January 1st the property is listed, it shall be allowed two years of depreciation."

But the cost base moves too. Counties "shall use the total retail cost when new each January 1st as the starting point for each year's valuation," and that figure "will typically increase each January 1st until such time as the construction is complete, then the cost will generally become consistent absent some unusual circumstance."

So during construction, two things happen at once each January 1: the cost base grows as more is built, and the depreciation count advances by a year. The directive's own summary: such property "shall be considered to be commercial and industrial machinery and equipment for valuation and classification purposes. Depreciation shall be allowed commencing with the first year the property is listed. The retail cost when new of the property shall be determined each January 1st until the construction is complete and the full retail cost when new of the machinery and equipment is known and established."

What this means for you

Manufacturers building equipment on site

The classification favors you relative to the alternative, and so does the depreciation timing. Equipment under construction is not parked in a higher-assessed "other" category while it is being built, and you do not wait for completion to start the depreciation clock — the first January 1 it is listed carries a full year of depreciation.

Be aware of the offsetting effect: your reported retail cost when new should rise each January 1 as construction adds to it, so the taxable figure is not simply declining during the build.

Businesses reporting personal property

Practical reporting point. A machine begun mid-year is listed on the immediately following January 1, not deferred. If your county has been leaving in-progress equipment off the roll until completion and then starting depreciation from zero at that point, that is not what this directive prescribes, and the difference compounds over the depreciation life.

Accountants and tax professionals

Note the two anchors the directive uses to define the base: A.G. Opinion #97-97 for the classification question, and Board of Leavenworth County Comm'rs v. McGraw Fertilizer Serv., Inc. for the meaning of "retail cost when new." The directive cites McGraw in its full form including the modification on rehearing.

Before applying any of this, confirm whether the equipment is exempt at all under current law. Kansas enacted broad machinery and equipment exemptions after this 1998 directive, and an exemption analysis comes before a valuation analysis.

Owners of real property under construction

Different question, different directive. Buildings and land with construction in progress are covered by companion Directive #98-031, which turns on whether the construction has added market value and whether the parcel is still a vacant lot.

Common questions

Q: Is my half-built machine taxed as machinery or as something else?
A: As commercial and industrial machinery and equipment. It "shall be considered to be commercial and industrial machinery and equipment for valuation and classification purposes."

Q: Why does that matter?
A: Assessment rate and valuation method. Machinery follows the constitutional formula and is assessed at 25%; "other" personal property is valued at fair market value and assessed at 30%.

Q: Does the stage of completion change the answer?
A: No. The property is listed at retail cost when new and depreciation begins the first year it is listed "without regard to the stage of completion."

Q: When does depreciation start?
A: The first January 1 the property is listed, with a full year allowed — the same treatment the directive illustrates with a desk bought mid-year.

Q: What is the valuation formula?
A: "Retail cost when new less straight-line depreciation over its economic life or a seven-year period, whichever is less," under Kan. Const. art. 11, § 1.

Q: Does my cost base change during construction?
A: Yes. The total retail cost when new is redetermined each January 1 and "will typically increase each January 1st until such time as the construction is complete."

Q: Where did this rule come from?
A: Attorney General Opinion #97-97, which concluded that equipment otherwise meeting the criteria "does not become 'other' property to be valued at market and assessed at a different rate merely because it is not yet in operation," read against art. 11, § 1.

Q: Is my equipment even taxable today?
A: Possibly not. This is a 1998 directive; Kansas later enacted significant machinery and equipment exemptions. Check current law first.

Citations and references

Authority for the directive: K.S.A. 79-505.

Constitutional formula: Kan. Const. art. 11, § 1 — commercial and industrial machinery and equipment valued at retail cost when new less straight-line depreciation over economic life or seven years, whichever is less; assessed at 25%. "Other" personal property valued at fair market value and assessed at 30%.

Case cited in the directive:

• Board of Leavenworth County Comm'rs v. McGraw Fertilizer Serv., Inc., 261 Kan. 901, 933 P.2d 698, modified 261 Kan. 1082, 941 P.2d 1388 (1997) — cited for the construction of "retail cost when new"

Attorney General opinion cited: A.G. Opinion #97-97.

Companion directive: #98-031, classification and valuation of real property under construction.

Source

• Landing page: Kansas Property Tax Directives
• Original PDF: PVD Directive 98-032

Original ruling text

State of Kansas
Kansas Department of Revenue
Division of Property Valuation

The following appraisal directive is adopted by the director of property valuation pursuant
to K.S.A. 79-505:

DIRECTIVE #98-032: Classification and valuation of commercial and industrial
machinery and equipment under construction.

A question has arisen as to how commercial and industrial machinery and equipment,
which is under construction on January 1st, should be valued and classified for property
tax purposes. Such property shall be listed at its retail cost when new and depreciation
shall begin the first year the property is listed for taxation without regard to the stage of
completion.

Prior to this directive, there were two schools of thought as to how such property should
be classified. These two views have differing tax ramifications, particularly after the
Kansas Supreme Court decision in Board of Leavenworth County Comm’rs. v. McGraw
Fertilizer Serv., Inc., 261 Kan. 901, 933 P.2d 698, modified 261 Kan. 1082, 941 P.2d
1388 (1997). If the property is considered to be “commercial and industrial machinery
and equipment,” it is valued in accordance with the constitutional formula set forth in art.
11, § 1 of the Kansas Constitution for such property and it is assessed at 25%. If the
property is not yet considered to be commercial and industrial machinery and equipment,
then it is classified as “other” personal property and it is value based upon its fair market
value and it is assessed at 30%.

In Attorney General Opinion #97-97, the attorney general opined that: “commercial and
industrial equipment that otherwise meets the criteria for classification as such does not
become ‘other’ property to be valued at market and assessed at a different rate merely
because it is not yet in operation.” The attorney general based the opinion upon a
common person’s understanding of the term “commercial and industrial machinery and
equipment” set forth in art. 11, § 1 of the Kansas Constitution.

County appraisers shall value commercial and industrial machinery and equipment that is
under construction on January 1st in accordance with Attorney General Opinion #97-97
and the formula set forth in art. 11, § 1 of the Kansas Constitution. County appraisers
shall construe the term “retail cost when new” for valuation purposes consistently with
the aforementioned McGraw Fertilizer case. County appraisers shall assess such property
at 25%.

Art. 11, § 1 of the Kansas Constitution requires that commercial and industrial machinery
and equipment be valued based upon its retail cost when new less straight-line
depreciation over its economic life or a seven-year period, whichever is less.

Page 2

When applying this constitution formula to commercial and industrial machinery and
equipment that is under construction on January 1st, county appraisers shall depreciate the
property in the same manner as other property in that subclass. For example, a new desk
that is acquired in the midst of a year is listed the immediately following January 1 st and it
is allowed one year of depreciation the first year it is listed. Similarly, here, when
commercial and industrial machinery and equipment is constructed on site commencing
in the midst of a year, it shall be listed the immediately following January 1st and it shall
be allowed one year of depreciation the first year it is listed. The second January 1st the
property is listed, it shall be allowed two years of depreciation. Depreciation for the
following years will follow suit in accordance with the language in the Constitution.

County appraisers shall use the total retail cost when new each January 1st as the starting
point for each year’s valuation. The retail cost when new of commercial and industrial
machinery and equipment that is under construction will typically increase each January
1st until such time as the construction is complete, then the cost will generally become
consistent absent some unusual circumstance.

In summary, commercial and industrial machinery and equipment that is under
construction on January 1st shall be considered to be commercial and industrial machinery
and equipment for valuation and classification purposes. Depreciation shall be allowed
commencing with the first year the property is listed. The retail cost when new of the
property shall be determined each January 1st until the construction is complete and the
full retail cost when new of the machinery and equipment is known and established.

APPROVED: June 12, 1998

Mark S. Beck
Director of Property Valuation