In Grand Lodge of Kentucky Free and Accepted Masons, et al. v. City of Taylor Mill et al., No. 2015-CA-001617-MR (Ky. App. Feb. 10, 2017) the Kentucky Court of Appeals held that the real property owned by a non-profit organization but occupied by senior citizens as their residence is subject to ad valorem taxation and not subject to the charitable exemption found in Section 170 of the Kentucky Constitution.

Grand Lodge of Kentucky Free and Accepted Masons (“Grand Lodge”) is a recognized public charity and generally receives the constitutional exemption from property taxes on real property it owns and occupies, as guaranteed by Section 170 of the Kentucky Constitution. The property at issue in this case is a 24-acre tract of real property that Grand Lodge leases to Masonic Retirement Village of Taylor Mill, Inc. (“MRV”). MRV is a nonprofit organization with a purpose of providing and maintaining affordable housing to senior citizens. It established a retirement community in the city of Taylor Mill, Springhill Village, which is located on the real property MRV leases from Grand Lodge.

Springhill Village consists of forty-eight residential units that are available to senior citizens over age fifty-five who could afford to purchase the unit. An individual interested in acquiring a unit would execute a “Resident Agreement” whereby the resident would agree to pay an entrance fee of $151,000 to $252,000. The resident retained exclusive right of possession to the unit during the term of the Resident Agreement, which terminated only upon death, mental or physical inability of the resident to inhabit the unit, resident relocation to a nursing home, or the resident’s thirty-day notice to terminate the agreement. After termination, the resident could be entitled to a refund of certain amounts of the entrance fee.

The Department of Revenue (“Department”) had long viewed Springhill Village as exempt from property taxation because it was owned by Grand Lodge, a charity. In 2011, Taylor Mill and Kenton County filed a petition for declaratory judgment in Kenton Circuit Court against the Department and the Kenton County Property Valuation Administrator (“PVA”), arguing that the residential units in Springhill Village were leased or transferred to private individuals and should be subject to property tax. The Kenton County Circuit Court agreed and held that the individual units were subject to property tax based on their fair market value.

The PVA issued tax assessments to each resident in 2012, 2013, and 2014, which the residents appealed to the Kentucky Board of Tax Appeals (“Board”). The Board found that the real property as a whole was exempt under the charitable property exemption because Grand Lodge and MRV were both public charities. The Board also found that the residents’ possessory interests were not enough to subject them to property tax. Taylor Mill and Kenton County appealed the result by filing an original action in Kenton Circuit Court, which held that the individual residents were non-exempt entities who would be subject to property tax. The Kenton Circuit Court reasoned that the rights held by the individual residents were significant and the individual units could not be exempt from tax. The Court then held that the total value of the residents’ interests in the 48 units was $6,491,000. The residents appealed to the Kentucky Court of Appeals.

The Court of Appeals first held that the residents, not Grand Lodge or MRV, were the occupants of the property for purposes of the constitutional tax exemption. The Court explained that the Resident Agreements gave the residents exclusive rights to occupy the property during the term of the agreement in exchange for consideration. The Court further held that there is no “occupancy” interest in real property, and that occupancy was instead a result of possession of real property. Thus, this possessory interest was enough to subject the residents to property tax under Section 170 and KRS 132.195.

However, the Court of Appeals went on to hold that the individual units should be considered as leaseholds for purposes of valuation. The Court explained that “[t]he law is well-settled that a leasehold’s fair market value for taxation purposes is obtained by subtracting the fair market value of the real property with the leasehold from the fair market value of the real property without the leasehold.” The Court held that the PVA had not used that formula to obtain the property tax assessments, and thus vacated the assessments. Therefore, the Court directed the PVA to “obtain the fair market value of the Resident’s specific property interest by subtracting the fair market value of the particular unit with the Resident’s leasehold from the fair market value of the unit without the leasehold. The difference constitutes the fair market value of the Resident’s possessory interest in that specific unit for ad valorem taxation purposes.”

This case should be of interest to any public charity in Kentucky who may lease property to private entities or individuals. However, the case is particularly relevant to retirement communities, nursing homes, or low-income housing organizations that structure their real property units in a similar manner to Grand Lodge and MRV. This case has affirmed the notion that a charitable purpose alone is not enough to obtain a tax exemption for property owned by a charity if it is occupied by a private person. That said, the Court has given some relief to taxpayers who occupy such properties. Individual residents should review their tax assessments carefully to ensure that they are being taxed on the value of the property as a leasehold, not as an owner-occupied property.