Office tenants who are occupying space under customary lease terms in New York City are obligated to reimburse the landlord for increases in real estate taxes over the negotiated amount or year referred to as the “base year amount”.
The base year is either a fiscal year, July 1 to June 30, or a calendar year, January 1 to December 31. Tenants are contractually obligated to pay their respective proportionate share of the increase in the building’s real estate taxes, by taking the current year’s tax amount minus the tax amount of the base year indicated in the lease. The fiscal year basis is commonly used in commercial leases because governments typically employ that cycle for real estate tax assessments and payments.
To be specific, let’s say a tenant signs a lease with a 2014/2015 fiscal base year, and the real estate tax for that fiscal year is $8.00 per rentable square foot. If the tax levied by the city increases to $8.50 per rentable square foot for the 2015/2016 fiscal year, the tenant pays $.50 per rentable square foot as additional rent to the landlord. If the taxes go up to $9.00 in the 2016/2017 fiscal year, then the tenant will pay $1.00 per rentable square foot.
The tenant should be aware of a number of nuances to the real estate tax provision, when negotiating a lease.
- A tenant should only pay taxes on the land and the building. A tenant should never pay a landlord’s personal, business, or sales taxes.
- The proportionate share of taxes that the tenant is obligated to pay should be calculated on the basis of rentable square footage of the tenant’s leased office space divided by the rentable square footage of the entire building. For example, if the tenant leases 10,000 rentable square feet in a 100,000-rentable-square-foot building, the tenant’s proportionate share will be 10 percent. **Especially in New York City where retail and office units are found in the same building; landlords sometimes do not include the retail space in the total rentable square feet of the building. If this is the case in your building, make sure that the landlord deducts the taxes attributable to the retail spaces from the total amount of tax due.
- Real estate taxes are calculated based on the income generated in the building; which is then capitalized by a factor to derive the market value of the building. Also, the value of the building is adjusted upward when improvements are done to the building.
- A tenant always wants to have the highest base amount to compare to taxes levied in future years. However, the highest base amount might not be a future year. It is entirely possible because of future vacancies, expiration of over-market leases or a number of other factors that this year or even a previous year might be the highest base year for comparison purposes.
- Sometimes as a result of tax certiorari proceedings (contesting the assessment in court), the landlord receives a reduction or refund in its real estate taxes. As a tenant, you are not automatically entitled to a “proportionate share” of that refund; unless it is specifically stated in your lease.
- You should always review your real estate tax statement every year to check for potential discrepancies.
- Remember, the base year is subject to negotiations. Pick one that affords you the greatest protection against increases.
- Always compare the taxes in your building to the taxes in similar buildings. Since buildings can have different development or leasing cycles; these comparisons can provide the tenant with some idea about what might happen to their taxes in the near or even more distant future.
New York City’s Department of Finance reviews the cash flow of the building and improvements done to the building to arrive at the building’s assessment each year. If there is a high vacancy rate in the building, taxes may be low. If the landlord subsequently rents it up the following year, your taxes could rise. Also, if the landlord puts significant improvements into the building, your taxes will rise. If he improves a largely vacant building, and then attracts high-paying tenants, your taxes will rise because of the improvements as well as the improved rent roll.
Lastly, you would want your first tax increase to occur at least one year after the possession date or rent commencement date so you will have at least one full year at the base rental rate you negotiated.
Remember, you should always have a real estate attorney review the clauses.
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