THIS DECISION WAS SIGNED BY JUDGE CARL N. BYERS ON NOVEMBER
22, 2000, AND FILED STAMPED ON NOVEMBER 22, 2000.
IN THE OREGON TAX COURT
DEPARTMENT OF REVENUE,
State of Oregon,
GRANT WESTERN LUMBER CO.,
Case No. 4394
Plaintiff Department of Revenue (the department) appeals
from a magistrate decision valuing an eastern Oregon sawmill
for the 1996-97 and 1997-98 tax years.
The appeal focuses on
the use of whole-plant sales and how to calculate functional
obsolescence; issues with state-wide implications.
Consequently, both parties exerted extraordinary efforts and
expended significant resources in support of their respective
The subject property is a sawmill in John Day, Oregon.
Originally constructed in 1974, it was designed to process
large pine logs.
The logs are taken from a cold deck or
storage area, put on a conveyor and moved through a ring
debarker that removes the bark.
The debarked log is then
placed on a carriage that moves the log through a stationary
Slabs that are cut off the log are removed by
chain transfers to edgers and trimmers that make more refined
cuts to create boards of various shapes and lengths.
boards then move onto a green chain (so named because the
lumber is not yet dried) where workers pull the boards off the
chain and place them into stacks according to size and grade.
The boards are then “sticker stacked” and placed in a kiln for
After drying, they are planed, packaged, and shipped
Originally the mill mostly produced shop-grade
boards for remanufacturing into pinewood products such as
molding and furniture.
Defendant Grant Western Lumber Co. (taxpayer) purchased
the mill in 1992.
Not long thereafter, taxpayer recognized
that large logs were becoming scarce and the older technology
of the mill was not efficient in processing smaller logs.
Accordingly, taxpayer added a small-log side:
“Optimil system” designed to maximize the recovery from
smaller logs (18 inches or less in diameter).
equipment consisted of another ring debarker, a quad-head
optimil, and a computerized edger.
That addition resulted in
the sawmill having two breakdown centers.
As of the assessment dates in question, the subject
property was to be valued at its real market value for
purposes of property tax assessment.
the owner of an industrial plant may elect to preserve
business confidentiality and keep plant-income data from the
If the owner makes this election,
neither the taxpayer nor taxing authorities may use the income
approach in valuing the property.
That leaves the appraisers
with only the cost approach and the sales comparison
The court will summarize the appraisal evidence
before addressing specific issues.
Summary of Appraisal Evidence
The department’s appraisers performed both a cost
approach and a sales comparison approach.
The department had
previously appraised the mill in 1988 and in 1995.
appraisers used those prior appraisals as a checklist while
inspecting the property for their appraisals for this case.
Their building and structure estimates are based primarily on
cost data published by Marshall and Swift Valuation Service.
All references to the Oregon Revised Statutes are to
At one time, ORS 308.411 also prohibited either side
from considering economic obsolescence or functional
obsolescence in valuing the property. Those restrictions were
lifted by 1995 legislation. Or Laws 1995, ch 724, § 1.
Consequently, their cost approach for buildings and structures
is replacement cost new (RPCN) less depreciation.
The appraisers obtained both new and used costs for
machinery and equipment.
Because the cost approach requires
an appraiser to estimate assemblage and equipment costs, they
estimated freight, concrete footings, platforms, supports,
installation labor (including power wiring, control wiring,
etc.), engineering, and overhead.
estimated new and then depreciated.
All of those costs were
In addition, the
appraisers estimated functional obsolescence and economic
The department’s appraisers found a total
reproduction cost new (RCN) for the mill of $18,445,201 and a
depreciated reproduction cost (DRC) of $6,965,500.
The department’s appraisers determined that 6 out of
17 sawmill sales east of the Cascades could be used in a
direct sales comparison of whole mills.
(Ptf’s Ex 1 at 51.)
Based on their analysis, those sales gave an indicated range
of $3 million to $7.5 million.3
(Ptf’s Ex 1 at 61.)
estimated $4 million for the subject plant.
The evidence established that the department’s “price”
for the Gilchrist sale of 7.5 million is in error. The
correct price was a little over $3 million. (Def’s Ex B at
561.) That greatly reduces the department’s range.
recognized that it is very difficult to compare sawmills so
different in design.
In addition, they concluded that
sawmills do not usually sell unless the mill is in trouble
and, therefore, there is no “active market” for sawmills.
(Ptf’s Ex 1 at 61-62.)
Consequently, in their reconciliation,
the department’s appraisers gave greater weight to the cost
approach of $4,675,000 over the market approach of $4 million
and concluded that the real market value
of the subject property as of July 1, 1996, was $4,550,000.
(Ptf’s Ex 1 at 63.)
Taxpayer’s primary appraiser was Robert Yunker, a former
employee of the Department of Revenue.
Yunker was in a unique
position since he appraised this same mill for the department
for a July 1, 1995, assessment.
As a senior industrial
appraiser, his 1995 estimated value was used in assessing the
mill for the 1995-96 tax year.
In that appraisal, Yunker
found a RCN of $13,086,100 (Def’s Ex C at 19), a cost approach
indication of $5,843,000, and a sales comparison approach
indication of $4,625,000 with a reconciled opinion of value as
of January 1, 1995, of $5,200,000.
(Def’s Ex C at 8-10.)
In this appeal, Yunker found a reproduction cost used
(RCU) of $5,581,000.
After deducting functional obsolescence
and economic obsolescence, he concluded that the real market
value of the subject property was $2,215,000 by the cost
(Def’s Ex A at 133.)
In the sales comparison approach, Yunker used 28
comparable sales, 6 of which occurred before 1991 and 22 after
The year 1991 was used as a benchmark because that was
federal court decisions protecting the spotted owl drastically
affected the amount of timber available from public lands.
Taxpayer’s appraisers adjusted the comparable sales for
differences in equipment, capacity, and other features in
Their first step was to break down the
purchase price of whole mills by allocating portions to the
various components, based upon the ratio of the RCN of the
component to the mill’s total RCN.
That portion of the
purchase price allocated to the component was then converted
to a price per capacity of board feet for sawmill planing, dry
kiln, boiler, and generator.
Using averaging and smoothing techniques, Yunker then
determined percentage adjustments for planing, drying, co-gen,
remanufacturing, and technology.
He estimated the level of
each sale relative to a standard or typical mill.
adjusted each sale relative to the subject’s position on that
He also adjusted for location and conditions of
Based on all of those adjustments and calculations, he
determined a range of price per capacity of board feet.
range was $11.08 to $21.59 per board foot of capacity.4
that, Yunker concluded that $18 per board foot of capacity was
the most appropriate number for the subject mill.
number, he found an indicated value by the sales comparison
approach of $1,800,000.
(Def’s Ex A at 30.)
Larry Tapanen, another very experienced appraiser,
conducted a market value to RCN ratio study (MV/RCN).
20 sawmill sales, he found that sawmills sell for between 3.45
percent to 18.25 percent of their RCN.
(Def’s Ex A at 43.)
Multiplying a RCN of $13 million for the subject plant by his
12 percent ratio gave him an indicated value of $1,560,000 for
the subject property.
(Def’s Ex A at 13.)
Taxpayer’s appraisers then reconciled the following
Cost Approach (Used Equipment)
Based on those numbers, they concluded that the subject
property had a real market value as of July 1, 1996, of
The range of $11.08-$21.59 is derived from four sales:
Nos. 36, 38, 71, and 72. (Def’s Ex A at 30.)
(Def’s Ex A at 31-32.)
For the years in question, ORS 308.205 provided that real
market value was the minimum amount in cash for which
properties would exchange between willing buyers or sellers.
The court has construed the statute to mean that property
should be valued at the low end of the range.
Rolling Mills, Inc., v. Dept. of Rev., 13 OTR 252, 254 (1995).
Real market value is to be determined by methods and
procedures that are in accordance with the department’s rules.
OAR 150-308.205-(D)(1995) indicates that a plant
such as the subject sawmill is to be valued as an assembled
unit, not by the market price of its component parts.
rule acknowledges that assembled value usually is greater, but
it is possible that it may be less than the total of its
addressing the sales comparison approach, OAR 150-308.205(D)(2)(d) (1995) states:
“Properties utilized in the sales comparison
approach, although not necessarily identical, at the
very least, shall be similar in many respects.
Adjustments shall be made for differences in location,
product, production capacity, and all other factors
which may affect value. Excessively large adjustments
or an excessive number of adjustments is an indication
that the properties are not comparable.”
That rule highlights a major problem in valuing woodproduct plants.
Obtaining reliable, accurate sales data that
meets the high standards of the department’s rules is very
Ideally, the rules are designed to create as
accurate an image as possible.
By analogy, they demand a
high-quality Carrara marble so a Michelangelo may create a
However, reality is more like a fir log from
which we must carve an upright grizzly bear with a chainsaw
The tax laws do not allow for waiting until ideal
A specific value must be determined so that
the tax can be imposed.
Therefore, the court must apply the
tools given to the materials at hand.
Sales Comparison Approach
The department’s appraiser used component replacement or
reproduction cost to make adjustments for differences in
For example, if a comparable sale had no planing
mill, the appraiser added the DRC of a planing mill to the
The 1992 sale of the subject property for
$2,840,000 was used as one of the comparable sales.
department added $1,988,500 as the DRC for the small-log side,
resulting in a total indicated value of $4,828,500.
1 at 55.)
The addition of the small-log side to the mill should
have increased its productive capacity to about 150,000 board
However, due to diminished log sizes and curved logs
that take longer to process, taxpayer realized no significant
increase in productive capacity.
The prior operator of the
mill reported actual production averaging 47,789,714 board
feet per year from 1984 through 1990.
(Ptf’s Ex 71.)
court’s calculations, taxpayer’s records show the sawmill
averaged only 45,344,333 board feet of production for the
years 1994 through 1996.
(Ptf’s Ex 17 at 5 & 11.)
In short, taxpayer added a small-log side, had a supply
of timber, incurred overtime expenses, ran two shifts per day,
and yet realized less production than the prior owner.
facts would indicate that the additional investment did not
significantly increase the mill’s value.
They also raise
questions about the department’s method.
Adding the DRC of a
component to a sale price to obtain an indicated value seems a
poor use of sales data.
Cost is not a good measure of value
where there is significant economic and functional
obsolescence, as is the case here.
The RCN of the small-log
side was approximately $3,300,000, and it was installed as
used equipment at a cost of $2,235,000.
estimated DRC of $1,988,500 represents 60 percent of its RCN
and 89 percent of taxpayer’s actual cost.
Those levels are
far above what the department has assigned the overall mill
and far above any of the sales data.
As noted, Tapanen performed a MV/RCN ratio study.
court recognizes there are questions about the accuracy of the
RCN figures used, the allocated sale prices, and
However, Tapanen had appraised a large number
of the comparable sales and was knowledgeable with regard to
their RCN and sale prices.
In the larger perspective, the
MV/RCN study provides some meaningful parameters.
department’s appraiser Taraleen Elliott agreed that if the RCN
and the prices are correct, the ratio gives a good measure of
Tapanen testified that in making the study he was trying
to find some “level of trade.”
By finding that the lowest
was 3.45 percent and the highest ratio was 18 percent, he
concluded that economic obsolescence is more in the range of
50 to 60 percent rather than the 30 percent the department has
Because of the wide range of ratios and the questions of
accuracy and comparability, the court is unwilling to accept
the ratio as a stand-alone method of estimating market value.
Nevertheless, it is based on market data and provides a range
If another method indicates a much higher ratio,
then some explanation or rationale is needed to support that
For example, the department’s estimate of real
market value of $4.8 million represents 26 percent of its
estimated RCN of $18 million.
The evidence does not support
such a high ratio.
The court finds that little weight can be given to
Yunker’s sales comparison analysis.
Exhibit J shows only one
sale involved a generation component.
There were also wide
variations in the price per component.
Dry kilns ranged in
price from $.40 cents to $4.90 per board foot of capacity and
1.81 percent to 24.5 percent of the purchase price.
estimating adjustment factors of 60 percent for the sawmill,
20 percent for the planing, 10 percent for the dry kiln, and
10 percent for the boiler, the appraiser is smoothing very
Yunker used those numbers to adjust the comparable sales.
For example, the technology of Gilchrist Timber (sale #1) was
adjudged to be at the 25 percent level whereas the subject was
estimated to be at the 30 percent level, resulting in a five
percent adjustment to the Gilchrist sale.
Adjustments for all
the various categories were then netted to determine a single
adjustment for the comparable to indicate a value for the
There are many weaknesses with that method.
a large number of judgments using data with wide ranges, both
in dollar terms and percentages.
The primary basis for
comparison is board feet of capacity or production, which the
court concludes is not a reliable measure.
indicates board feet of capacity should be a good measure of
comparison, the evidence indicates otherwise.
Gloudemans testified, if board feet of capacity was an
accurate basis for comparison, mills of the same capacity
should sell for about the same price.
They do not.
range per board foot of capacity was from $4.10 to $36.13.
(Def’s Ex J.)
When the adjusted prices have such a wide
range, it suggests the averages are not very meaningful.
the court’s view, it is a valiant effort to make sense out of
very complex data.
Although board feet of capacity must be
one of the critical factors for buyers, the evidence does not
persuade that it drives market prices.
Taxpayer introduced a statistical analysis of the
comparable sales performed by Dr. Hal Heaton.
was intended to answer two questions.
First, is the price at
which a sawmill sells significantly related to its board feet
analysis concluded that: Yes, capacity is a statistically
significant determinant of price.
Using a least-squares regression analysis, Heaton found a
very high probability that capacity affects price.
the R2 indicates that capacity can explain only 22 percent of
the variation in price.
Gloudemans, the department’s expert,
testified that 22 percent is not enough for capacity to
It leaves 78 percent of the variation to be
explained by other factors.
Although board feet of capacity
is important, so are the other variables.
He pointed out that
roughly half of the sales fall outside the $7.93 to $22.41
range. (Def’s Ex T at 9.)
However, both Gloudemans and
another department expert admitted that it is possible to use
capacity to predict price if one includes the intercept.
this case, Heaton used a price per board foot of capacity of
When that is multiplied by 100,000 board feet of
capacity, it results in $1,517,000.
If Heaton’s intercept of
$695,280 is added, it gives a total indicated value of the
subject property of $2,212,280.
Ex T at 4.)
The second question the analysis asks is: “Did the
environmental issues involving the spotted owl in early 1991
significantly affect the sale price of lumber mills?”
Ex T at 1.)
Again, Heaton found that there is over a 99
percent probability that environmental issues did affect sale
prices and that sale prices went down from approximately
$31.35 per board foot of capacity to $16.25 per board foot of
Heaton applied two tests to verify this conclusion.
The department submitted rebuttal testimony by a professor in
applied statistics who noted that although there is a very
between the spotted owl and lumber mill prices, “correlation
doesn’t mean causation.”
There is no quicker way to introduce confusion into the
mind and error into the record than for the court to try and
resolve methodological disputes between statistical experts.
Fortunately, it is not necessary.
The Heaton analysis shows a
very strong relationship between capacity and price.
that strong relationship or confidence interval is only with
regard to that one variable.
Using a best-point estimate for
one variable to predict the price would be like trying to
predict the price of a car based on mileage alone.
Intuitively, one knows that there is a great difference in
price between a 10-year-old car whose paint is faded and body
is rusting and a car with the same mileage that is one year
old with leather interior and a new-car smell.
The court believes that it would be error to conclude the
slope coefficient establishes that the price for the subject
mill would fall within a range of $7.93 to $22.41 per board
foot of capacity.
(Def’s Ex T at 9.)
true only with regard to one variable.
That inference would be
Other variables can
move the price
outside that range in either direction.
“These data confirm that the value of a mill can
be determined within a reasonable pricing range by
adjusting for only a few variables. * * *.
“* * * a handful of adjustments will lead to a fairly
accurate estimate of the price at which a mill will
sell. * * *.” (Def’s Ex T at 9.)
Regression of one independent variable is not reflective
of a “few” or “a handful” of variables that would explain 80
90 percent of the mill’s price.
It does not take an expert to
know that some of those variables are age, condition,
location, and other similar characteristics.
factors were not regressed or incorporated into the study.
Taxpayer contends that with capacity explaining 22
percent of the variation in price and the spotted owl
15 percent of the variation of price, those two factors
account for approximately 40 percent of the variance.
However, the spotted owl ruling affected timber supply and
timber supply affected productive capacity.
To the extent
that the spotted owl affected capacity, it is not simply
In summary, the statistical conclusion that there is a
significant relationship between price and capacity merely
confirms one’s intuition.
The best-point estimate plus the
intercept does constitute a sign post along the way, helping
point us in the right direction to real market value.
However, the court does not believe it is the destination
The department appraisers apparently performed both a RCN
and a RCU approach.
They found a RCN of $18,445,201.
The court is unable to find a summary that helps make
sense of their many pages of field notes.
In the absence of
summaries or some explanatory notes, there is some concern
For example, the “tray sorter” mentioned in
Plaintiff’s Exhibit 16, installed in 1988, is a tray sorter in
the planing mill.
That tray sorter is not to be confused with
the tray sorter that replaced the green chain after the
assessment date (mentioned in calculating functional
Plaintiff’s Exhibit 16 indicates that the DRC
for the RCN approach was $6,965,500.
The department’s RCU
approach arrived at a value of $6,922,400, which is remarkably
close to the DRC.
(Ptf’s Ex 1 at 93.)
appraiser then deducted $242,365 for functional obsolescence
and 30 percent or $2,004,011 for economic obsolescence.
In comparison, Yunker found a RCU of $5,581,000.
(Def’s Ex A at 133.)
He deducted $2,416,000 for functional
obsolescence and 30 percent or $950,000 for economic
obsolescence, arriving at an indicated value of $2,215,000.
Thus the two main differences between the parties in the
cost approach is a difference of $1,384,500 in the initial DRC
and a difference of $2,173,635 in the amount of functional
The difference in DRC is largely in the area of machinery
Taxpayer questions the department’s number
because, by the court’s calculations, a 1988 department
appraisal done by Roger K. Blomberg had a RCN of only
$14,645,030 and a DRC without functional or economic
obsolescence of $6,229,960.
(Def’s Ex C at 292-94.)
the 1988 appraisal notes, Yunker found a RCN of $13,086,100
for January 1, 1995.
(Def’s Ex C at 308.)
questions how Yunker could estimate a RCN of approximately one
and a half million dollars less than Blomberg when there is no
evidence that any equipment was removed.
To the contrary,
over $3 million of equipment (RCN) had been added in the
The court has spent a significant amount of time
examining Yunker’s field notes and has found some errors.
appeared that Yunker failed to trend some cost figures, (Ptf’s
Ex 63), and omitted some assets such as the bridge across the
(Ptf’s Exs 64-66.)
However, according to the court’s
calculations, his RCN is still only $14,194,037.
The parties have a theoretical dispute with regard to the
calculation of functional obsolescence.
To avoid unnecessary
confusion, the court will use the same terms utilized by the
parties during the course of trial.
Although the court will
decide only the issues presented by the parties, some
contextual discussion is necessary to understand the basis for
resolution of this issue.
“Functional obsolescence is caused by a flaw in the
structure, materials, or design that diminishes the function,
utility, and value of the improvement.”
The Appraisal of Real Estate 365 (11th ed prtg 1999) (hereafter
referred to as 11 edition).
Functional obsolescence exists
only by comparison; there is no loss in value unless some
alternative is better.
Functional obsolescence is only
deducted in the cost approach.5
Therefore, any measure of
functional obsolescence must be consistent with the theory and
assumptions of the cost approach.
The goal in calculating
functional obsolescence is to reflect how the market would
value the subject property using the cost approach.
There is a distinction between functional obsolescence
due to excess capital costs and functional obsolescence due to
excess operating costs.
“The difference between reproduction and replacement
cost represents the amount of excess capital cost. *
* * Calculating operating obsolescence involves a
comparison of the operating characteristics of the
subject property to its modern equivalent.” American
Society of Appraisers, Appraising Machinery and
Equipment 98 (John Alico ed 1989).
If flaws in the subject property impose higher operating
costs than its modern equivalent, the market will pay less for
However, the modern equivalent plant may require
The direct sales comparison approach and the income
approach to value inherently reflect all forms of
greater capital expenditures to achieve the lower operating
Therefore, the cost of the modern alternative must be
considered when estimating functional obsolescence.
calculating functional obsolescence, the appraiser must stay
true to the cost approach.
That means no property can be
deducted from cost unless it has been first included in the
One of the first determinations that must be made is
whether the flaw in the subject property is “curable.”
is, could the owner obtain an increase in net present value by
incurring the cost of correcting the flaw and thereby achieve
lower operating costs?
The parties agree that if the cost to
greater than the net present value of the loss (minus taxes),
the flaw is considered “noncurable.”
If it is determined that
the flaw is noncurable, the net present value of the loss
(minus taxes) is used in calculating functional obsolescence.
If the flaw is curable, the cost to cure is used in
calculating functional obsolescence.
The parties also agree that there is a difference between
functional obsolescence caused by a deficiency and functional
obsolescence caused by a defect.
A deficiency means the
subject property is missing some machine or equipment
(machine) and therefore incurs greater operating costs than a
plant with that machine.
A defect means that a machine in the
subject plant is less efficient or more costly to operate than
a machine performing an equivalent function in the modern
These definitions are consistent with the terms
“deficiency requiring an addition” and ”deficiency requiring
substitution or modernization” contained in the 11th edition at
The concept of “cost to cure” is largely undisputed by
It is the cost that would be incurred in
changing the subject property to correct the flaw.
subject property suffers from a deficiency, the cost to cure
would be: (1) the cost of the missing machine, and (2) the
cost of installing that machine.
The parties agree that
installing a machine in an existing property may be more
expensive than installing the same
machine when a plant is constructed new.
To the extent the
cost is greater, it is referred to as “excess” cost.
If the subject property suffers from a defect, the cost
to cure would be the total of: (1) the cost to remove the
machine, (2) the remaining DRC of the defective
The department does not agree that the remaining DRC of
the defective machine is part of the cost to cure.
its salvage value), (3) the cost of the new machine, and (4)
the cost of installing the new machine.
The dispute between the parties arises not so much from
the concepts as from the calculations applying the concepts.
That may be due to the fact that when calculating functional
obsolescence, one is hypothesizing an addition in order to
calculate a deduction.
This mental gymnastic requires one to
consider market motives while staying true to the assumptions
of the cost approach.
Because cost is used as a surrogate for
value, calculations of functional obsolescence must relate to
the cost of the subject property.
Confusion may also arise from imprecise application of
It is important to understand that cost to cure
is not the same as functional obsolescence.
is important because curing the flaw results in a different
property than the subject property whose value is being
The parties agree that the amount of functional
obsolescence due to a curable deficiency is “excess cost to
The market will penalize the subject property only to
the extent of the excess or extra costs incurred in curing the
The market will not penalize the property for the
cost of the missing machine because it was never in the
If it is a curable deficiency and there is
no excess cost to cure, there is no functional obsolescence
even though there are “excess” operating costs.
because it is not the subject property that causes the excess
operating costs, but the absence of some property.
that incurs excess labor costs because it is missing a machine
that could do the job of ten workers may be deficient as an
operating unit, but reproduction cost is still a good measure
of the value of that existing mill.
The mill’s labor costs
are only excess when compared to a plant that has the machine.
What must be remembered is that the machine can be
obtained only at additional cost.
Correcting the deficiency
by adding the missing machine will add to the reproduction
cost of the mill, not diminish it.
Therefore, in a curable
deficiency situation, only the excess cost to cure is
Considered from the owner’s point of view, the
owner has the option of selling the plant “as is” (DRC less
excess cost to cure) or incurring the cost of adding the
machine and selling the plant for a greater amount.
buyer’s point of view, it can purchase the property “as is”
and add a new machine or it can construct a new plant with
that kind of machine in it.
As indicated, the parties agree this is the proper
measure of functional obsolescence to deduct from reproduction
cost in the case of a curable deficiency.
That is consistent
with the explanation set forth in the 11th edition at 388:
“Since the item is not present, the property
cannot be penalized for any depreciation the item may
have incurred. However, because it usually costs more
to add an item to an existing property, the excess
cost to cure is what the property is penalized for.”
The parties do not agree on the amount that should be
deducted from the subject’s reproduction cost where there is a
curable defect in the subject.
Taxpayer and its experts
believe the full amount of the cost to cure should be
deducted, including the cost of a new machine.
the department and its experts believe only the capital cost
differential plus the excess cost to cure should be deducted.
The court finds problems with both party’s calculations.
The court disagrees with taxpayer’s position with some
Taxpayer’s expert, Dr. William M. Kinnard, Jr. has
been an eminent authority in valuation methods for almost half
His explanations of why the value added by a cure
should be ignored due to the risks of recovery were cogent and
Nevertheless, as he acknowledged, the whole point
of calculating functional obsolescence is to value what is
there, not the property as cured.
If the full cost to cure is
not offset by the cost of the replacement item as if installed
new, as provided for in the 11th edition’s five-step method,
the effect is to treat the property as cured.
functional obsolescence measures the loss in value in the
subject property, not the gain in value from curing the
defect, the cost to cure must be offset by the cost of the
replacement item as if installed new.
The court rejects taxpayer’s method of calculating
functional obsolescence because not offsetting the cost of the
new machine against the cost to cure undervalues the subject
As indicated above, the parties agree that if there
is a curable deficiency, the cost of the new machine should be
offset against the cost to cure.
A defect condition can be
made into a deficiency condition by deducting the DRC (less
salvage value) of the defective machine from the reproduction
cost of the subject property.
By removing the DRC of the
defective machine, the remaining reproduction cost of the
plant is the same as if the defective machine had never been
If the machine had never been
installed, the flaw would be a deficiency, not a defect.
Because the parties agree that the cost of the new machine
should be an offset in the case of a deficiency, logic
requires the same treatment where the DRC of the defective
machine is deducted as part of the cost to cure.
In evaluating whether to purchase the subject property,
with its defective machine, or build an alternative with a
good machine in it, the buyer will compare total costs.
example, assuming a curable defect, the buyer would weigh the
replacement cost of the new machine in a new plant ($100)
against the total of: (a) the DRC of the defective subject
machine ($10) plus
(b) the excess cost of installing a new machine in the subject
property ($5) plus (c) the cost of the new machine ($100).
Obviously, the buyer can choose to spend $100 for the machine
in a new plant or $115 to purchase the defective subject
machine and replace it with a new machine.
will give the buyer a new machine.
However, we are not
valuing the subject property with a new machine in it (cured).
We are using reproduction cost to measure the value of the
subject property as its exists with its defect.
In that “as
is” condition, the market will penalize the subject property
only $15 for functional obsolescence because that is the
difference between the two alternatives.
The additional cost
of obtaining the new machine is not a penalty against the
subject because the RCN of the subject does not include that
If an additional $100 is
deducted from the RCN as a penalty for functional
obsolescence, it undervalues the subject property.
The department’s six-step method raises a number of
questions on its face.
From the point of practicality, for
whole-plant comparisons, it requires the appraiser to do a
complete replacement-cost approach and a complete
Whether such expenditures of time
and resources are justified is questionable.
the formula may be mathematically pure, the facts of the real
world are rarely pure.
This case is a good example.
the age and nature of the improvements, the department’s own
appraisers used a mixture of RCN, RPCN, and RCU to value the
Neither the taxpayer nor the department has
a pure RCN or pure RPCN estimate.
Consequently, the exactness
of analysis implied by the method can be illusory.
Even if theoretically correct, the department incorrectly
applies its method of calculating functional obsolescence.
Exhibit 34, another department appraiser Robert DePuy compares
the 11th edition five-step method with the department’s sixstep method in calculating functional obsolescence associated
with the green chain.
In the six-step method, he consistently
used replacement cost used (RCU).
However, in the five-step
method, he employed RCU in the cost to cure but offset it with
an “estimated” RPCN, resulting in a nonsensical negative
number for functional obsolescence.
If he had consistently
used either RPCN or RCU in the five-step method, he would have
derived a positive number for functional obsolescence.
would be true even if there was no excess cost to cure because
there was $181,600 of DRC that would be included as part of
the cost to cure.
Calculating a negative functional obsolescence number
should immediately alert an appraiser that his or her
calculation is in error.
In Exhibit 35, DePuy uses $45,900 as
a cost to cure for a trimmer lug speed defect.
replacement cost if installed new is shown as $147,140.
Again, mismatching costs or equipment produces a nonsensical
number for functional obsolescence of a negative $68,705.
Based on the explanation of the trimmer lug speed defect
in his appraisal report (Ptf’s Ex 1 at 119-25), DePuy did not
have enough information to calculate functional obsolescence.
The value of the loss is “unknown” and therefore it is unknown
whether the flaw is curable.
Also, the remaining depreciated
cost of the existing lug loader is not shown.
knew only part of the cost to cure and assumed the defect was
The explanation in the appraisal report does show the
cost of a conversion kit at $16,700.
(Ptf’s Ex 1 at 119.)
That would appear to be excess cost to cure since a new
installation should not require a conversion kit.
If that is
the case, the department’s calculated functional obsolescence
of $15,165 using the six-step method is less than the excess
cost to cure alone.
A clearly wrong result.
The method set
out in the 11th edition, a widely accepted authoritative text,
appears to accommodate all forms of functional obsolescence.
That is the method the court will use in resolving the dispute
in this case.
The parties agree that the subject mill’s green chain
incurs excess operating costs when compared with the use of a
The net present value of those excess operating
costs is $2,379,300.
(Ptf’s Ex 1 at 94.)
green chain is $181,600.
The DRC of the
The cost of a new tray sorter is
$750,000, and the excess cost (removing the green chain and
installing the tray sorter) is $40,000.
Clearly, the defect
is curable because the cost of curing the defect ($181,600 +
$750,000 + $40,000 = $971,600) is less than the value of the
The amount of functional obsolescence deductible from the
reproduction cost of the subject property is $181,600 +
$40,000 or $221,600.
The $750,000 is not deductible because
it was never in the reproduction cost of the subject property.
It would be inconsistent with the logic of the cost approach
to deduct the cost of an item that was never included in the
That becomes apparent if the subject property has many
In such a case, if the cost of the new
machines are deducted as an element of functional
obsolescence, the total indicated value could be negative when
in fact the subject
property produces a positive net cash flow and therefore has
The department disputes specific items of functional
obsolescence claimed by taxpayer.
(a) inutility of the canter and board edger,
(b) excess space in office and truck shop, and
(c) the lack of a railhead.
Yunker deducted $1,116,000 for inutility of the optimil.
(Def’s Ex A at 135.)
This was done on the premise that the
mill was designed to process between 3,000 to 5,000 logs
(average 4,000) in an eight-hour shift when in fact the mill
only 800 to 1,200 logs per shift.
Using an accepted formula,
he calculated the functional obsolescence at 51.5 percent.
The court finds several problems with Yunker’s deduction.
First, the deduction for inutility assumes that taxpayer could
incur less capital cost to obtain the same production.
evidence indicates that the cause of the underproduction is
the nature of the logs, particularly curved logs.
is some evidence that other less expensive technology could be
used, it does not appear to be as efficient in either speed or
Second, Yunker deducted functional obsolescence for
the edger as well as the optimil.
The evidence established
that the problem is with the initial sawing of the log, not
edger that processes the cants.
If Yunker’s logic was
followed, all of the rest of the mill suffers functional
Yunker also found the office building was 25 percent
larger and the truck shop was 50 percent larger than what
(Def’s Ex A at 136.)
Those estimates were
based on his judgment as to what usual mills have.
testimony was too general and imprecise to justify those
No specific evidence was introduced to show what
portions of either of those facilities would not be used by
Neither building seems to be so unusually large
that a significant percentage should be deemed functionally
Yunker deducted $435,000 as functional obsolescence for
lack of a railhead.
This is based on estimating that absence
of a railhead required 20 percent excess product handling.
Ex A at 137.)
The court is not persuaded that lack of a
railhead constitutes functional obsolescence.
The test is
whether the market, in considering the subject mill versus
other mills, will discount the value of the subject because of
lack of a railhead.
As the department’s witnesses point out,
there are many considerations when considering the location of
Based on the evidence submitted, the court is not
persuaded the market would devalue the subject property
In summary of the cost approach, it appears that Yunker’s
$13 million RCN is low.
Because it is likely that the RCN is
closer to $18 million than $13 million, the court concludes
that the DRC should be closer to $6,965,500 than $5,843,000.
Deducting functional obsolescence of approximately $250,000,
as estimated, the approach indicates a value of $6,715,500
before economic obsolescence.
Another measure of cost would be taxpayer’s purchase
price in 1992 for $2,840,000 (buildings and structures and
machinery and equipment), plus the cost of the small-log side
that was $2,235,000, for a total of $5,075,000.
Both of those
measures have to be reduced by subsequent economic
The department estimates economic obsolescence
at 30 percent and the taxpayer estimates it at 50 to 60
Using those figures, the upper range for the
“traditional” cost approach would be $4,700,850 (30 percent x
$6,715,500) or $3,552,500 (30 percent x $5,075,000 and the
lower range would be $3,357,750 (50 percent x $6,715,500) or
$2,537,500 (50 percent x $5,075,000).
In trying to arrive at a determination of value, there
are some facts that are clear.
technology less valuable.
First, small logs make older
The evidence indicates that if
taxpayer had not installed the small-log side, the mill would
probably be closed today.
The spotted owl and screen 21 restrictions affected
market prices of mills.
The effect of those government
restrictions were well publicized and the impact was wide
DePuy testified that many mills closed.
It is also clear that annual production of the subject
mill did not increase despite the addition of the small-log
As taxpayer’s counsel pointed out, “What buyer would
pay twice as much to obtain less production?”
Whatever may be said about the roughness and
inconsistencies of comparable sales when viewed in board-feet
capacity, it is clear that overall, the ratio of market value
to RCN is low.
It is also clear that most of the competing
mills such as Gilchrist Lumber, Blue Mountain, Crown
Pacific/Alebeni Falls, and Bonner’s Ferry/Coeur D’Alene all
fall in the 10 to 12 percent of RCN range.
If Tapanen’s 12
percent ratio was applied to the department’s $18 million RCN,
it gives an indicated value of $2,160,000.
newness of the small-log side added just before the assessment
date, an appropriate ratio might be closer to 14 percent
($2,520,000) or 15 percent ($2,700,000).
Another perspective would be to multiply the older
$14,645.030 RCN of Blomberg by 12 percent to indicate a value
of $1,757,403 and then add something for the optimil or smalllog side.
The small-log side, which cost $2,235,000 in 1995,
would have suffered both physical depreciation and functional
and economic obsolescence by July 1, 1996.
Because much of
the optimal equipment was installed used and as an addition to
an older mill, the court estimates that 50 percent should be
deducted for functional and economic obsolescence.
leaves $1,117,500 which, when added to the $1,757.403, gives
an indicated value for the subject property of $2,874, 903.
Finally, Heaton’s statistical study with the value of the
intercept indicates a value of $2,212,280.
In light of the above, the court believes the lower range
of the traditional cost approach ($3,357,750 to $2,537,5000)
is probably more reflective of real market value.
indicated, because the small-log side was added just prior to
the assessment date, the court believes that the ratio of RCN
to value should be higher than Tapanen’s 12 percent.
of 14 percent to
15 percent would indicate a value of $2,520,000 to $2,700,000.
Recognizing the mill must be valued as a single-operating unit
and at the “minimum” amount for which it would exchange hands
in the marketplace, the court finds that the real market value
the subject property as of July 1, 1996, was $2,700,000, and
as of July 1, 1997, was $2,500,000.
Judgment will be entered
in accordance with this determination.
Costs to neither
Dated this ___ day of November, 2000.
Carl N. Byers