Billboards Continue To Be Taxed As Personal Property
The Arizona Court of Appeals handed down a decision on March 7, 2001 that throws out a test used by American courts for 150 years to distinguish personal property from fixtures. Known as the Teaff test from a case in 1853, case law since that time has relied on certain criteria to determine when and if personal property become fixtures to real property. This is important in billboard cases because of differences in taxes on the two types of property, and because personal property is not compensable in some eminent domain cases.
Other courts do not have to follow the decision or reasoning of this case known as Arizona Outdoor Advertisers, but it will not be ignored entirely in other jurisdictions. We have reproduced excerpts from the decision below. For a full understanding of the opinion and the full text see Arizona Department of Revenue v. Arizona Outdoor Advertisers, Inc., Court of Appeals, Division One, March 7, 2002.
Related reading: My Commercial Lease is Going to Expire… What Happens Next?
In this (sales) tax case, the Arizona Department of Revenue appeals from a judgment adverse to its attempt to treat Arizona Outdoor Advertisers’ income from the rental of billboard space as income from the commercial leasing of real property. Arizona Outdoor claims that its billboards, erected on real property owned by and leased from others, are personal property and should be classified as such. The resolution of this dispute depends on whether the billboards, after they are erected, become “fixtures” and part of the realty or remain personalty. The Tax Court found that the billboards remained personalty and, because we agree with this result, we affirm. In doing so, however, we depart from the traditional fixtures analysis used by the Tax Court and employ a modified approach that does away with some confusing legal fictions and unnecessary evidentiary restrictions imposed by traditional analysis.
Arizona Outdoor had twelve billboards in place.
Arizona Outdoor leased land for a fifteen-year term. The lease agreements provide in pertinent part:
8. Lessee shall have the right to permit others to place signs owned by them on the [billboard], and such signs shall be subject to the terms and conditions of this Lease. It is agreed between the parties that Lessee, or such other person, as the case may be, shall remain the owner of all of said advertising signs, structures and improvements, and that, notwithstanding the fact that the same constitute real estate fixtures, the Lessee or such other person, as the case may be, shall have the right to remove said signs, structures and improvements at any time during the term of this Lease, or after the expiration of this Lease.
The affidavit of William Pearson, Sr., Arizona Outdoor’s corporate president, states: “Any language in the lease agreements relating to the billboards being real estate fixtures is inadvertent, having come from boilerplate in another contract.” The Department does not controvert this assertion.
Arizona Outdoor can terminate a lease at the end of any monthly period merely on thirty days’ advance notice. The Lessor can terminate on thirty days’ advance notice before the end of a lease term, or by notifying Arizona Outdoor that it intends to improve its land by building a permanent commercial or residential building. Upon termination, Arizona Outdoor has the right to remove the billboard structure from the realty.
Arizona Outdoor has consistently removed its billboards over the years as billboard locations ceased satisfying their intended purpose or lessors decided upon another use for their property.
The Department audited Arizona Outdoor for the period August 1988 through July 1992 and determined that its gross income from sign rentals was income from the commercial lease of real property under Arizona Revised Statutes . . . . on appeal, the Arizona Board of Tax Appeals sustained Arizona Outdoor’s position and concluded that Arizona Outdoor was not liable for an assessment under the real property commercial leasing classification.
The Department brought this action in the Arizona Tax Court challenging the Board’s ruling. The court applied traditional fixtures analysis and found that notwithstanding the affixation of the billboards to the land and their adaptation to use with real property, they never became part of the realty because “[t]he record supports Defendant’s contention that the billboard structures were intended, and did in fact remain the Defendant’s personal property.”
The Department contends that the billboards constitute improvements to real property within the meaning of subsection (f) (2), whereas Arizona Outdoor contends the billboards are personalty and fall under A.R.S. 42-5071 (Supp. 2001), which imposes a transaction privilege tax on income from the leasing of personal property. We must determine which assertion is correct.
To resolve the issue, the court adopted a test from a South Dakota case involving the same company engaged in the same activity, and applied the following criteria to decide that the substation was an improvement to real property:
1) its actual or constructive annexation to the realty;
2) its adaptability to the use and purpose for which the realty is used; and
3) the intention of the party making the annexation.
This three-part test to determine an “improvement to real property” is in fact the traditional test for determining whether an item of personal property has become a “fixture.” The test originated in Teaff v. Hewitt, 1 Ohio St. 511 (1853), and is designed to ascertain whether and when goods lose their identity as personalty and become part of the realty, thereby becoming subject to the laws governing realty.
“[I]mprovement” is a broader category of things than “fixture” and encompasses everything that permanently enhances the value of premises for general use. Improvement certainly includes fixtures, but the term also includes such things as roads or ditches that usually are not classified as fixtures. [B]ecause fixture is a narrower category of things than improvement, it is important to acknowledge that while it is sometimes appropriate to employ fixtures criteria to test for realty improvements, sometimes it is not.
[I]f the billboards are fixtures, they necessarily are improvements. Conversely, if they are personalty they cannot be improvements because the temporary nature of their occupancy means that they do not permanently enhance the value of the realty. [T]he bulk of the reported cases concerning billboards employ some variation of fixture analysis. See, e.g., Aquafine Corporation v. Fendig Outdoor Advertising Co., 272 S.E. 2nd 526 (Ga. Ct. App. 1980) (billboards were personalty or removable trade fixtures); City of Cleveland v. Zimmerman, 253 N.E. 2d 327 (Ohio Prob. 1969) (billboards were personalty, not fixtures); Creative Displays, Inc. v. South Carolina Highway Department, 248 S.E. 2d 916 (S.C. 1978) (billboards were not fixtures and were therefore not compensable as realty).
[T]eaff ” put forth a formula, which has been almost slavishly repeated by the American courts ever since.” Walter B. Raushenbush, Brown on Personal Property, §16.1 at 516 (3d ed. 1975) (hereinafter “Brown”).
[I]t continues to be almost universally applied by American courts even though it injects an irrelevancy into the decision-making process, creates an awkward fiction that misdirects the inquiry, and requires contorting the language to achieve just and consistent results.
[B]ecause the test rests on the annexor’s intent as of the time the personalty is physically affixed, it illogically makes that point in time the only relevant focus for a fixtures inquiry. This temporal limitation results because Teaff uses the physical act of annexation both as its starting point and its ending point. The test directs that if the affixation consists of an actual physical connection of the personalty to the realty, the personalty becomes a permanent part of the realty at the instant of affixation so long as it complements the use to which the land is put and the annexor, at that particular moment, intends the personalty to permanently join the realty.
Professor Polston illustrates the absurdity of focusing on intent at affixation to create such important consequences. He notes that when annexation is accomplished by the owner of the realty, the owner’s intent is irrelevant because, in actuality, no enforceable legal consequences attach at that point. The owner can remove the personalty at will and without penalty, and if he does, those “forever” consequences suddenly evaporate. Id., §46.02(b) (3) at 521-22. Thus, ascertaining the intent of the annexor at affixation often yields only an irrelevancy, yet the Teaff test treats it as controlling.
Intent as a test element should be measured as of a time when it is probative of something material. For example, the status of the purported fixture may be brought into question when the owner decides to sell the land. Click here to learn how to sell house fast. Professor Polston notes that if the parties in their sales agreement fail to account for the item and its character becomes an issue
To the extent that intention is a factor in making such a determination, it must be an intention that is common to the parties to the relationship.
Id. §46.02(b) (3) at 522.
Thus, in a two-party relationship, when intent factors into the characterization of an item, it should be the present, mutual intent of the parties to the agreement. Id. It borders on the irrational to resolve a problem arising from a present transaction by harking back to a time before the parties’ agreement, and resting the resolution on the intention of the original annexor, who may not even be a party to the present transaction. Id. At 522-24.
[S]ome courts have construed the search for objective intent as precluding evidence of the subjective intent of the annexor, whether he is the owner of the realty or one of the parties to the transaction giving rise to the present dispute.
We nevertheless believe that a reasonable person test, if property constructed, is a preferable alternative to Teaff. Such a test would permit the hypothetical reasonable person to consider all the circumstances that might be relevant to the particular case, and he would have the flexibility to consider those circumstances as of a point in time when they are material, not just as of the time when the item was originally affixed. Thus, the test for whether an item of personalty has become part of the realty would be stated as: Would a reasonable person, after considering all the relevant circumstances, assume that the item in question belongs to and is a part of the real estate on which it is located?
However, we do not extend the reasonable person test beyond the taxation context because the question whether such a test would have the same beneficial effect in other legal contexts is too large to be answered here.
The agreements unequivocally declare that Arizona Outdoor would remain the owner of the billboards, and the agreements grant Arizona Outdoor the right to remove the billboards.
As to how this right of removal should be viewed, we note that when an item of personalty truly transmutes into a fixture, it becomes a part of the realty and ownership normally passes to the person holding title to the land. Powell, §57.04(4) at 57-19 to 57-20. But a continuing right by a non-landowning annexor to remove the item would be inconsistent with ownership passing to the landowner. Thus, if there is a right of removal, the reasonable person would conclude that ownership of the item did not pass to the landowner and the item is therefore not a fixture.
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