A common financing structure for resort hotels in Colorado and other parts of the U.S. is for the developer to sell part or all of the development to individuals for fee simple ownership. Under some circumstances, individual owners may opt to retain the management services of the hotel, or a third-party management company, for rental of their condominium. This can occur especially in resort communities, such as Vail, Colorado, where vacation homes and condominiums are purchased for occasional use by the owner and are available for nightly rental when not in use by the owner.
In a property tax appeal involving the iconic Lodge at Vail (LAV), Eagle County sought to include certain rental management income as part of the property’s taxable net operating income (NOI). In the early 1960s, the LAV was initially constructed as a 60-room hotel and the first lodging property in the Vail Valley. As the popularity of Vail grew, the LAV building was expanded to include more hotel rooms and an equal number of privately owned condominium units. Since the inception of the expansion in the early 1970s, an affiliate of the hotel operator and other third-party management companies have executed property management service contracts with the third-party condominium owners. Colorado-assessing officials had excluded the third-party rental income for the hotel operator’s operating NOI. This includes the LAV until 2017 when Eagle County decided to treat the property management rental income as a part of the hotel's taxable real property interest. Consequently, the litigation described below ensued.
Case Law–Wisconsin Precedence and Colorado Court of Appeals Reversal
Following the lead in a Wisconsin Supreme Court (“the Court”) decision concerning the assessment of the Abbey on Geneva Lake Resort (ABKA Limited Partnership v. Board of Review of the Village of Fontana-on-Geneva-Lake), the Court found that the property management services business was “inextricably intertwined” with the real property and thus includable in the property’s NOI for property tax valuation purposes. On September 17, 2020, a Division of the Colorado Court of Appeals (COA) rendered a decision in the Lodge Properties Inc. v. Eagle County Board of Equalization, reversing the Board of Assessment Appeals (“the Board”). The Board found that revenue derived from the rental of third-party owned residential condominium units constituted an intangible asset that, while it might be considered in the valuation of a property outside of taxation, did not reflect additional value to the subject real estate. The Board reached its conclusion after consideration of the International Association of Assessing Officers (IAAO) Special Committee on Intangibles, titled “Understanding Intangible Assets and Real Estate: A Guide for Real Property Valuation Professionals,” as probative evidence in its determination. The Board noted the following test in its decision: “The key of the analysis is whether the value is appended to the property, and is thus transferrable with the property, or whether it is, in effect, independent of the property so that the value either stays with the seller or dissipates upon sale.”
The COA found that net income from the condominium would be transferable with the sale of the LAV, thus considered as in the market value, according to Colorado law. Secondly, although the only rights the LAV has to the condominium net income are based on cancellable contract agreements with the owners, the COA found that the condominium net income is not an intangible asset since it is an identifiable, measurable and continual source of revenue. The COA finding was that the condominium net income did not qualify as either an intangible asset, general intangible or intangible property, citing Black’s Law Dictionary as the relevant authority for these definitions. The Court went on to find that “the ability of the LAV property, including the condominiums, to generate income is largely due to the integrated nature of the resort.” Finally, the COA found that the condominium net income is an “identifiable and measurable stream of income attributable to the LAV real property.”
Colorado Supreme Court Decision
The LAV appealed the decision to the Colorado Supreme Court, and on February 22, 2022, the Court rendered its decision reversing the COA’s. The Supreme Court ruled in favor of the LAV on four basic principles: (1) the revenue generated by separately owned condos was not permitted; (2) that the rental management agreement contracts were separate and divisible from the LAV’s real property; (3) that legally distinct parcels of real property must be separately valued and appraised, finding that unlike in Roberts v. Adams, the inclusion of business value in a property assessment should be the exception, not the norm. Accordingly, the Wisconsin case law on which Eagle County relies is inapposite. And finally, (4) the Court was unpersuaded by the public policy concerns raised by Eagle County and its amicus (other Colorado Counties). In fact, Eagle County was the only county that included property management contributions in valuation hotel properties.