                                STATE OF MINNESOTA

                                 IN SUPREME COURT

                                        A14-1883
                                        A14-2168

Tax Court                                                                     Wright, J.
                                                              Took no part, Lillehaug, J.

Guardian Energy, LLC,

                            Relator,

vs.                                                              Filed: August 12, 2015
                                                              Office of Appellate Courts
County of Waseca,

                            Respondent.

                              ________________________

Thomas R. Wilhelmy, Jennifer A. Kitchak, Fredrikson & Byron, P.A., Minneapolis,
Minnesota, for relator.

Marc J. Manderscheid, Michael M. Sawers, Briggs and Morgan, P.A., Minneapolis,
Minnesota; and

Brenda Miller, Waseca County Attorney, Waseca, Minnesota, for respondent.

Robert Small, Executive Director, Minnesota County Attorneys Association, Saint Paul,
Minnesota; and

John March, Senior Hennepin County Attorney, Jane N.B. Holzer, Thomas F. Pursell,
Assistant Hennepin County Attorneys, Minneapolis, Minnesota, for amicus curiae
Minnesota County Attorneys Association.
                           ________________________

                                       SYLLABUS

       1.     The tax court’s determination that the ethanol-plant tanks are taxable real

property is not clearly erroneous.


                                            1
      2.       The tax court’s valuation of the ethanol plant is not reasonably supported

by the evidence as a whole because the tax court based its calculation of external

obsolescence on an analysis that is not supported by the record and failed to adequately

explain the method it used to calculate external obsolescence.

      Affirmed in part, vacated in part, and remanded.

                                      OPINION

WRIGHT, Justice.

      In a proceeding before the Minnesota Tax Court, relator Guardian Energy, LLC,

challenged respondent Waseca County’s assessment of the value of its ethanol-

production facility. In this appeal from the tax court’s order for judgment, Guardian

Energy argues that the tax court erred by (1) classifying 27 tanks1 used in the ethanol-

production process as taxable real property and (2) determining the fair market value of

the property based on an analysis of external obsolescence that is unsupported by the

record. We affirm the tax court’s determination that the tanks are taxable real property.

But because the tax court failed to adequately explain its calculation of external

obsolescence, and based that calculation on an analysis that is not supported by the

record, we vacate the tax court’s valuation of the facility and remand for further

proceedings.




1
        The term “tanks” refers to the various tanks and distillation columns that are used
in the ethanol-production process at Guardian’s facility.


                                            2
                                            I.

      The property at issue in this appeal is Guardian Energy’s ethanol-production

facility located on 141 acres in Janesville. The plant converts field corn into ethyl

alcohol (ethanol). Guardian Energy, a joint venture of six midwestern ethanol entities,

purchased the nearly completed plant in 2009 for $92 million after the former owners

filed for bankruptcy during its construction. Guardian Energy completed construction of

the plant and commenced operations in October 2009. The property consists of three

adjoining tax parcels that contain an industrial complex of buildings, tanks, distillation

columns, wells and septic systems, a rail spur, and other land improvements.

      The Waseca County Assessor estimated that the market value of the property was

$24,167,100 as of January 2, 2009; $22,157,600 as of January 2, 2010; and $26,564,200

as of January 2, 2011. Guardian Energy challenged the assessments by filing timely

petitions with the tax court. See Minn. Stat. § 278.01, subd. 1 (2014). In 2012, the

parties filed cross-motions for partial summary judgment to resolve whether certain tanks

at the plant were taxable. After a two-day hearing in January 2013, the tax court

concluded that the disputed tanks were taxable real property2 within the meaning of




2
       The tax court issued its initial order on February 21, 2013. Guardian Energy
moved for reconsideration, and the tax court amended its memorandum in support of its
findings of fact and conclusions of law several months later. Guardian Energy, LLC v.
Cty. of Waseca, No. 81-CV-10-365, 2013 WL 684242, at *1 (Minn. T.C. Feb. 21, 2013)
reconsideration granted in part, No. 81-CV-10-365, 2013 WL 8719413 (Minn. T.C. July
9, 2013).




                                            3
Minn. Stat. § 272.03, subd. 1 (2012).3 The matter proceeded to trial in February 2014 to

determine the fair market value of Guardian Energy’s facility, and both parties introduced

expert appraisal testimony. Guardian Energy’s expert, Robert Strachota of the Shenehon

Company, valued the property at $20,320,000 as of January 2, 2009; $20,120,000 as of

January 2, 2010; and $19,690,000 as of January 2, 2011. Waseca County’s expert, Clay

Dodd of Patchin Messner Dodd & Brumm, valued the property at $26,590,000 as of

January 2, 2009; $29,100,000 as of January 2, 2010; and $33,990,000 as of January 2,

2011.

        After receiving the parties’ post-trial briefs, the tax court issued its findings of fact

and conclusions of law in September 2014. Following Guardian Energy’s motion for

amended findings of fact, conclusions of law, or new trial, the tax court issued amended

findings of fact, conclusions of law, and an order for judgment in December 2014.4 The


3
       The Legislature amended Minn. Stat. § 272.03, subd. 1, in 2014 to provide that the
exterior shell of a structure used in the production of biofuels, wine, beer, distilled
beverages, or dairy products, is not included in the definition of real property, even when
the shell has structural, insulation, or temperature control functions. Act of May 20,
2014, ch. 308, art. 2, § 9, 2014 Minn. Laws 1875, 1892-93 (codified at Minn. Stat.
§ 272.03, subd. 1(c)(iii) (2014)). The exterior shell of the structure, however, is real
property when it is used primarily for storage of ingredients or materials used in the
production of biofuels, wine, beer, distilled beverages, or dairy products, or the storage of
those finished products. Id. This amendment is effective beginning with assessment year
2015. Id. As did the tax court, we rely on the pre-amendment version of the statute to
determine the taxable nature of the tanks.
4
       Before the tax court issued its amended findings of fact, conclusions of law, and
order for judgment in December 2014, judgment was entered inadvertently. Guardian
appealed that judgment to preserve its right to appeal. Guardian subsequently filed a
separate appeal from the December 2014 order of the tax court. We consolidated the two
appeals in our January 8, 2015 order.


                                                4
tax court determined that the fair market value of the property was higher than the

parties’ appraisal evidence presented at trial. See Guardian Energy, LLC v. Cty. of

Waseca, No. 81-CV-10-365, 2014 WL 7476215 (Minn. T.C. Dec. 9, 2014).

       A summary of the fair market values, as proposed by the parties and as found by

the tax court, is as follows:

            Year          County         Guardian        County’s       Tax Court
                         Assessment      Energy’s        Expert at      Amended
                                         Expert at         Trial         Order
                                           Trial
            2009         $24,167,100    $20,320,000    $26,590,000     $36,379,100

            2010         $22,157,600    $20,120,000    $29,100,000     $34,834,200

            2011         $26,564,200    $19,690,000    $33,990,000     $38,593,000


       In determining the fair market value, the tax court used a cost approach to

valuation that considered the value of the land, plus the replacement cost of the

improvements to the land, with deductions for depreciation based on external

obsolescence.5 The tax court’s estimated replacement cost for the real property, the

replacement cost new (RCN), was within the ranges of the replacement costs calculated

by the appraisers. However, in deducting for external obsolescence, the tax court rejected


5
       External obsolescence refers to a type of depreciation understood generally as a
“loss in value caused by . . . factors outside a property.” Appraisal Inst., The Appraisal of
Real Estate 632 (14th ed. 2013). The causes of external obsolescence “can be broadly
characterized as either market obsolescence or locational obsolescence.” Id. at 633
(emphasis omitted). Locational obsolescence “is caused by proximity to some
detrimental influence on value such as heavy traffic, a landfill, or other undesirable land
use.” Id. Market obsolescence is the “result of the natural expansion and contraction of
the real estate market.” Id. Only market obsolescence is at issue in this appeal.


                                             5
the analysis of both parties’ appraisers and calculated a level of external obsolescence

that was considerably lower than the estimates that Guardian Energy and the County

submitted at trial. This calculation resulted in a final assessed value for each tax year that

was significantly higher than the values proposed by either party. Guardian Energy

sought review by our court, challenging the tax court’s determination that the tanks on

the property are taxable real property and the tax court’s calculation of external

obsolescence.

       Our review of the tax court’s decision is limited to determining whether the tax

court had jurisdiction, whether its decision is supported by the evidence, and whether it

committed an error of law. 444 Lafayette, LLC v. Cty. of Ramsey (444 Lafayette II), 830

N.W.2d 25, 29 (Minn. 2013); see Minn. Stat. § 271.10, subd. 1 (2014). We review the

tax court’s legal conclusions de novo, but we defer to the tax court’s market value

determinations unless they are clearly erroneous. See Eden Prairie Mall, LLC v. Cty. of

Hennepin (Eden Prairie II), 830 N.W.2d 16, 20 (Minn. 2013); Cont’l Retail, LLC v. Cty.

of Hennepin, 801 N.W.2d 395, 398 (Minn. 2011). The tax court’s value determinations

are clearly erroneous when they are not reasonably supported by the record as a whole.

Equitable Life Assurance Soc’y of the U.S. v. Cty. of Ramsey, 530 N.W.2d 544, 552

(Minn. 1995). Accordingly, we will not defer “to the tax court’s valuation determination

when the tax court has clearly misvalued the property or has failed to explain its

reasoning.” Cont’l Retail, LLC, 801 N.W.2d at 399.




                                              6
                                            II.

       We first address Guardian Energy’s argument that the tax court erred when it

determined that certain tanks at the facility are taxable real property.6 The tax court

began its valuation analysis by identifying the structures on the land that are subject to

taxation. Although the parties agreed that the land and the buildings on the land are

taxable real property, they disagreed about whether 27 tanks are taxable. The disputed

tanks serve various functions in the ethanol-production process and, in general, are bolted

6
       Guardian also argues on appeal—contrary to its position at trial—that it failed to
present sufficient evidence to rebut the prima facie validity of the County’s assessment
and, as a result, the County’s original assessment should stand. A county’s
presumptively valid tax assessment, Minn. Stat. § 271.06, subd. 6 (2014), may be
successfully challenged with credible evidence that the assessor’s estimated market value
is incorrect, S. Minn. Beet Sugar Coop. v. Cty. of Renville (SMBSC), 737 N.W.2d 545,
558-59 (Minn. 2007). Here, in response to Guardian’s attempt at trial to rebut the
County’s market valuation, the County conceded that it was not defending its initial
assessment because it had failed to include certain taxable items in that assessment. The
tax court correctly concluded that Guardian had successfully rebutted the presumption of
validity.

       Guardian now argues that the tax court could not both reject almost all of
Guardian’s evidence regarding valuation and find that Guardian had produced “credible
evidence” to rebut the presumption of prima facie validity. We disagree. The record
establishes that Guardian and the County agreed at trial that the County’s original
assessment was not valid. This agreement between the parties stands. See Minn. Vikings
Football Club, Inc. v. Metro. Council, 289 N.W.2d 426, 430 (Minn. 1979) (“It would be
impossible for a court system to function if the representations of attorneys, particularly
in the presence of and with the acquiescence of their clients, could not be relied upon.”).
Moreover, Guardian presented sufficient evidence to overcome the presumption of prima
facie validity afforded to the assessor’s estimated market value for the subject property,
even if that evidence was insufficient for purposes of valuation. See SMBSC, 737
N.W.2d at 590 (“[T]o overcome the presumed validity of the county’s estimated market
value, [a taxpayer] need not necessarily put forth evidence that would allow the tax court
to determine the market value of the subject property. Rather, [a taxpayer] need only put
forth evidence to show that the county’s assessed value does not reflect the true market
value of the property.”).


                                            7
to or sit on concrete foundations or piers. The tax court concluded that all of the disputed

tanks are taxable real property. Guardian Energy, LLC v. Cty. of Waseca, No. 81-CV-10-

365, 2013 WL 8719413 (Minn. T.C. July 9, 2013).

       All real and personal property is taxable unless otherwise exempt. Minn. Stat.

§ 272.01 (2014). Minnesota Statutes § 272.03, subd. 1(a) (2012), broadly defines “ ‘real

property’ ” for taxation purposes as “the land itself . . . and all buildings, structures, and

improvements or other fixtures on it.” See also S. Minn. Beet Sugar Coop. v. Cty. of

Renville (SMBSC), 737 N.W.2d 545, 551 (Minn. 2007). However, the tools, machinery,

and equipment used in the property’s production activity or business are excluded from

the definition of real property. Minn. Stat. § 272.03, subd. 1(c)(i). But this exclusion for

equipment and machinery does not apply to structures with exterior shells that have

“structural, insulation, or temperature control functions or provide[] protection from the

elements.”   Minn. Stat. § 272.03, subd. 1(c)(iii).       Such structures are taxable real

property.

       We most recently addressed the application of section 272.03, subdivision 1, to

industrial tanks in SMBSC when we affirmed the tax court’s conclusion that 30 tanks,

bins, and silos at a sugar beet processing plant were taxable real property. 737 N.W.2d at

550, 552-54. In so holding, we outlined the three steps necessary to determine whether

such tanks are taxable real property:

       The first step is to determine if the property at issue falls within the broad
       definition of real property in subdivision 1(a). The second step is to
       determine whether the exclusion in subdivision 1(c)(i) applies. And the
       third step is to determine whether the exception to the exclusion, set forth in
       subdivision 1(c)(iii), applies.


                                              8
Id. at 552. Applying section 272.03, subdivision 1, to the present case, the first step is to

determine whether the tanks are real property. Second, if the tanks are equipment or

machinery, they are excluded from the definition of real property and therefore are not

taxable unless the exception applies. Third, tanks that otherwise would be excluded as

machinery or equipment are taxable real property if they have an exterior shell that

“constitutes walls, ceilings, roofs, or floors if the shell . . . has structural, insulation, or

temperature control functions or provides protection from the elements.” Minn. Stat.

§ 272.03, subd. 1(c)(iii).

       Here, the tax court expressly relied on the analytical framework articulated in

SMBSC to determine whether the disputed tanks are real property. First, the tax court

determined that all of the disputed tanks (1) fall within the broad definition of real

property; (2) are structures within the meaning of subdivision 1(a); and (3) because they

are attached to concrete foundations, “sit[] on the land” within the meaning of that

section. See id., subd. 1(a) (“[R]eal property includes . . . all buildings, structures, and

other improvements or fixtures on [the land] . . . .”). For those tanks that are located

within buildings, the tax court determined that they are permanent additions to the facility

and are an integral part of the plant’s ethanol production process within the meaning of

Minn. Stat. § 272.03, subd. 1(b) (“A building or structure shall include . . . all

improvements or fixtures annexed to the building or structure, which are integrated with

and of permanent benefit to the building or structure.”).




                                               9
       Guardian Energy contends that the tax court erred in this first step of the SMBSC

analysis. According to Guardian Energy, because the tanks are attached to concrete

slabs, they are not on the land as required under subdivision 1(a). Guardian Energy also

argues that the tanks are moveable and, therefore, are not integrated and permanent under

subdivision 1(b). Thus, the tax court erred, Guardian Energy argues, by determining that

the tanks are taxable real property under step one of the SMBSC analysis. We disagree.

       As the tax court correctly explained, under Guardian Energy’s theory, it is difficult

to imagine what structures, other than those “sitting directly on the earth itself,” could

ever constitute real property.   Guardian Energy’s arguments fail to account for our

holding in Crown CoCo, Inc. v. Commissioner of Revenue, 336 N.W.2d 272, 273-74

(Minn. 1983), in which we concluded that a canopy that sheltered gas station pumps and

was “bolted to concrete footings” was a “structure” subject to taxation.          Guardian

Energy’s contention that the tanks are not “permanently affixed” to the land because

theoretically they could be removed (either by detaching them from their foundations and

then disassembling them or by towing the tanks away) fares no better. Permanency is not

synonymous with perpetuity, nor does it require the physical impossibility of removal.

See, e.g., Barton Enters., Inc. v. Cty. of Ramsey, 390 N.W.2d 776, 777-78 (Minn. 1986)

(affirming the tax court’s conclusion that two oil tanks were real property subject to

taxation despite being used tanks that were purchased by petitioner and moved to their

present site); Veolia ES Rolling Hills Landfill, Inc. v. Cty. of Wright, No. 86-CV-06-6446,

2007 WL 4845558, at *6 (Minn. T.C. Nov. 21, 2007) (concluding that a landfill liner was




                                            10
an improvement to real property because even though “it is physically possible to remove

the liner from its present site, its removal is unlikely”).

       The tax court correctly concluded that the disputed tanks fall within the definition

of real property in subdivision 1(a) and (b). See SMBSC, 737 N.W.2d at 552 (noting that

the definition of real property in section 272.03, subdivision 1(a) is broad enough to

include objects that resemble equipment); Barton, 390 N.W.2d at 777 (concluding that oil

tanks were taxable as real property because part of their function was to contain and

shelter petroleum products); KDAL, Inc. v. Cty. of St. Louis, 308 Minn. 101, 103, 240

N.W.2d 560, 561 (1976) (“The terms ‘structure’ and ‘equipment’ are not mutually

exclusive.”).

       Having determined that the tanks are real property under step one, the tax court

turned to the second step of the SMBSC analysis. Under the second step, the tax court

considered whether the tanks fall within the definition of equipment under subdivision

1(c)(i) and, therefore, are excluded from taxation. To satisfy the definition, the tanks

must be “machinery . . . and equipment attached to or installed in real property for use in

the business or production activity conducted thereon.” Minn. Stat. § 272.03, subd.

1(c)(i).   “To be exempt as equipment, an item must perform functions distinct and

different from the functions ordinarily performed by buildings and other taxable

structures.” Crown CoCo, Inc., 336 N.W.2d at 274. The tax court determined, and we

agree, that 13 of the 27 tanks are not excluded as equipment or machinery, and thus,

remain taxable real property.       However, the tax court found that, because of the

production activity of the remaining 14 tanks, these tanks meet the definition of


                                               11
machinery and equipment under subdivision 1(c)(i).         Therefore, these 14 tanks are

excluded from taxation as real property unless, under the third step of the SMBSC

analysis, the exception to the exclusion applies.

       Finally, under the third step of the SMBSC analysis, the tax court considered

whether the 14 tanks that are excluded as equipment under subdivision 1(c)(i)

nonetheless should be considered taxable real property because their exterior shells have

“structural, insulation, or temperature control functions or provide[] protection from the

elements.” Minn. Stat. § 272.03, subd. 1(c)(iii). The tax court concluded that the exterior

shells of the otherwise-excluded tanks have structural, insulation, or temperature-control

functions; provide protection from the elements; or perform a structural function by

preventing their contents from escaping. See SMBSC, 737 N.W.2d at 553 (concluding

that the tax court did not clearly err when it found that various tanks, bins, and silos

located at a sugar beet processing facility “perform[ed] a structural function” and

therefore were not excluded from taxation).

       The record supports the tax court’s factual findings that the tanks are real property

under Minn. Stat. § 272.03, subd. 1(a)-(b), and that those tanks that might be excluded

from taxation as equipment are nevertheless still taxable because their exterior shells

have “structural, insulation, or temperature control functions or provide[] protection from

the elements.” Id., subd. 1(c)(iii). Because the tax court did not clearly err in its legal

analysis, we affirm the tax court’s determination that the 27 tanks are real property

subject to taxation.




                                              12
                                            III.

       We next consider whether the tax court’s market-valuation conclusions are

supported by substantial evidence in the record. Guardian Energy argues that the tax

court erred when it “employed an analysis of external obsolescence that was not

supported by the appraisal testimony in the record, and as a result, [reached] values

significantly higher than the range of the appraisal evidence.”

                                            A.

       Before we address the matter of external obsolescence, we review the appraisal

approach used by the tax court. For taxation purposes, real property typically is assessed

at its “market value.”    Minn. Stat. § 273.11, subd. 1 (2014).         “Market value” is

represented by “the usual selling price,” namely, “the price which could be obtained at a

private sale or an auction sale, if it is determined by the assessor that the price from the

auction sale represents an arm’s-length transaction.” Minn. Stat. § 272.03, subd. 8

(2014). Generally, we have recognized three approaches to appraising real property to

determine its market value: (1) the sales-comparison approach, which compares the

subject property to similar properties recently sold in actual market transactions; (2) the

cost approach, which estimates the current cost to construct a reproduction of the subject

property; and (3) the income-capitalization approach, which capitalizes the income the

subject property is expected to generate over the relevant time period. Cont’l Retail,

LLC, 801 N.W.2d at 402; SMBSC, 737 N.W.2d at 555; see also Appraisal Inst., The

Dictionary of Real Estate Appraisal 17, 67, 143, 255 (4th ed. 2002) (listing the same

three methods).


                                            13
       After engaging in a comprehensive examination of the three approaches, the tax

court determined that the cost approach provides the most reliable indicator of the value

of Guardian Energy’s property. Neither party has challenged the tax court’s use of this

approach.7   While appraisers should apply at least two approaches to value when

possible, Equitable Life Assur. Soc’y of the U.S., 530 N.W.2d at 553, a tax court can “rely

exclusively on the cost approach when valuing special purpose property” such as an

ethanol plant.8 SMBSC, 737 N.W.2d at 556; see also In re McCannel, 301 N.W.2d 910,

924 (Minn. 1980) (“The very nature of special purpose property is such that market value

cannot readily be determined by the existence of an actual market, and therefore other

methods of valuation, such as reproduction cost, must be resorted to.”).          The cost


7
        Guardian’s appraiser estimated the property’s market value using the three
traditional approaches: sales comparison, income capitalization, and cost. The County’s
appraiser relied primarily on the cost approach, disregarded the income approach, and
considered the sales-comparison approach. The tax court rejected the sales approach that
Guardian used, concluding that the sales on which Guardian relied were not comparable
because they were missing critical data, arose out of a bankruptcy estate, or were part of a
stock-purchase transaction. The tax court similarly rejected the County’s sales approach.
The tax court also rejected Guardian’s income approach for reasons that are not at issue
in this appeal.
8
       The tax court found, and the parties agree, that Guardian’s ethanol plant is a
special-purpose property. A special-purpose property is a “property that is treated in the
market as adapted to or designed and built for a special purpose.” Fed. Reserve Bank of
Minneapolis v. State, 313 N.W.2d 619, 621 (Minn. 1981). Because of “its unique
function or design,” a special-purpose property “is not likely to be sold on the market and
cannot readily be converted to other uses.” Am. Express Fin. Advisors, Inc. v. Cty. of
Carver, 573 N.W.2d 651, 656 (Minn. 1998). Given the structure, design, and current use
of Guardian’s property as an ethanol-production facility, we agree that its conversion to
another use would not be “economically feasible or practical.” See The Appraisal of Real
Estate, supra, at 269. As such, the ethanol plant is properly classified as a special-
purpose property.


                                            14
approach is useful for estimating the market value of new or relatively new construction,

as is at issue here, and the cost approach is “best applied ‘when land value is well

supported and the improvements are new or suffer only minor depreciation.’ ” Cont’l

Retail, LLC, 801 N.W.2d at 403 (quoting The Appraisal of Real Estate 382 (13th ed.

2008)).

       The land value determined by the tax court—$8,500 per acre for 2009 and 2010,

and $9,000 per acre for 2011—is not at issue on appeal. Further, we are satisfied, based

on a careful review of the record, that the tax court’s RCN analysis for the taxable

improvements at the property is thorough, detailed, and exhibits independent analysis.

See Eden Prairie Mall, LLC v. Cty. of Hennepin (Eden Prairie I), 797 N.W.2d 186, 195

(Minn. 2011) (holding that a tax court’s “ ‘findings should reflect the court’s independent

assessment of the evidence’ ” (quoting In re Children of T.A.A., 702 N.W.2d 703, 707 n.2

(Minn. 2005))). Because it found the estimates of the County’s expert appraiser to be

more reliable and credible than Guardian Energy’s, the tax court’s RCN for the real

property at issue is supported by the evidence in the record.9

                                             B.

       We now address the calculation of external obsolescence. With the total RCN of

the real property calculated, the tax court next determined the amount of depreciation to


9
       The tax court concluded that, as of January 2, 2009, the estimated RCN for the real
property was $41,878,560. Guardian’s total estimated RCN for that date was
$34,170,000; Waseca’s total estimated RCN was $46,289,348. The difference between
the tax court’s RCN and the RCN estimates offered by Guardian and the County is
$7,708,560 and -$4,410,788, respectively.


                                            15
deduct from that value. See Cont’l Retail, LLC, 801 N.W.2d at 403 (explaining that

under the cost approach, “the appraiser determines the current cost of constructing the

existing improvements on the property, subtracts depreciation to determine the current

value of the improvements, and then adds the value of the land to determine the market

value” (citing Harold Chevrolet, Inc. v. Cty. of Hennepin, 526 N.W.2d 54, 56 (Minn.

1995))).   The three forms of depreciation under the cost approach are physical

depreciation, functional obsolescence, and external obsolescence. Empire State Bank v.

Lyon Cty., 454 N.W.2d 616, 617 (Minn. 1990).            Only the calculation of external

obsolescence is at issue here.

       Also referred to as economic obsolescence, external obsolescence is “[a]n element

of depreciation; a defect, usually incurable, caused by negative influences outside a site

and generally incurable on the part of the owner, landlord, or tenant.” The Dictionary of

Real Estate Appraisal, supra, at 106.      Put differently, external obsolescence is the

measurement of a property’s loss in value as a result of factors beyond the physical

boundaries of the property and beyond the owner’s control. External obsolescence “often

relates to the business enterprise that operates at the special-purpose property,” such that

a change in industry conditions could cause the taxpayer to incur a reduction in revenue,

profit margin, or return on investment metrics.        Robert F. Reilly, Functional and

Economic Obsolescence Procedures in Valuing Industrial Property, J. Multistate Tax’n

& Incentives, Sept. 2012, at 20, 27.

       The tax court’s analysis of external obsolescence resulted in a percent deduction

that was dramatically lower than either party’s position at trial, as shown below:


                                            16
                  Year         Guardian     County’s    Tax Court’s
                               Energy’s    Reduction at  Reduction
                               Reduction    Trial for       for
                                  for      Obsolescence Obsolescence
                              Obsolescence
                  2009           33.3%        45%          16%

                  2010            33.3%             35%              8%

                  2011            33.3%             25%              0%


In financial terms, the stark difference between the tax court’s external obsolescence

calculation and the parties’ positions constitutes millions of dollars in assessed tax value.

In 2011, for example, when the tax court deducted nothing for external obsolescence, the

County’s and Guardian Energy’s appraisers calculated deductions of $11,141,058 and

$5,813,847, respectively.

       The tax court was not persuaded that the parties’ methods for calculating external

obsolescence adequately connected industry-wide market conditions to Guardian

Energy’s property. Consequently, after rejecting each party’s method, the tax court

employed an entirely different method of calculating external obsolescence, using

evidence derived from the record.         Guardian Energy argues that the tax court’s

calculation of external obsolescence is clearly erroneous because neither the tax court’s

method for analyzing external obsolescence, nor the resulting market values, are

supported by the appraisal testimony in the record.




                                             17
                                            1.

      Minnesota Statutes § 278.05, subd. 1 (2014), instructs the tax court to “hear and

determine the claims, objections or defenses made by the petition and . . .            direct

judgment to sustain, reduce or increase the amount of taxes due.” The tax court may

arrive “at a value determination that is lower or higher than the appraisal testimony

presented at trial,” Eden Prairie I, 797 N.W.2d at 194, and need not accept the valuation

of either appraiser, Am. Express Fin. Advisors, Inc. v. Cty. of Carver, 573 N.W.2d 651,

658 (Minn. 1998). But when the tax court rejects the testimony of both appraisers, the

tax court must indicate the basis for its calculation and adequately explain its rationale

and the factual support in the record for its conclusions. 444 Lafayette, LLC v. Cty. of

Ramsey (444 Lafayette I), 811 N.W.2d 106, 107 (2012). In Eden Prairie I, we observed:

      [T]he tax court brings its own expertise and judgment in valuation matters,
      and its determination need not be the same as the appraisal testimony. But
      market value determinations involve the exercise of complex and
      sophisticated judgments of market conditions, anticipated future income,
      and investor expectations, particularly with respect to income-producing
      properties such as the subject properties here. When the tax court
      concludes that the market value of a subject property is lower or higher
      than the appraisal testimony, it should carefully explain its reasoning for
      rejecting the appraisal testimony and the grounds for adopting a lower or
      higher value, and adequately describe the factual support in the record for
      its determination. If the court fails to do so, it runs the risk of having its
      determination overturned.

797 N.W.2d at 194 (emphasis added).

      Both parties’ appraisers agreed that, on the three dates of valuation, the subject

property suffered from external obsolescence caused by prevailing negative industry

conditions.   The tax court explained that a taxpayer’s burden in proving external



                                           18
obsolescence “ ‘requires a showing of the cause of the asserted obsolescence and proof

that it affects the value of the subject property.’ ” Guardian Energy, LLC v. Cty. of

Waseca, No. 81-CV-10-365, 2014 WL 7476215, at *41 (Minn. T.C. Dec. 9, 2014)

(quoting Eurofresh, Inc. v. Graham Cty., 187 P.3d 530, 531 (Ariz. Ct. App. 2007)).10

The Eurofresh analytical framework reflects the requirement that external obsolescence,

such as that caused by an industrywide product decline, for example, must in fact affect

the subject property. 187 P.3d at 538.

       Applying this analytical framework, the tax court determined that Guardian

Energy was required to “offer probative evidence (1) of the cause of the claimed

obsolescence, (2) of the quantity of such obsolescence, and (3) that the asserted cause of

the obsolescence actually affects the subject property.” Guardian Energy, No. 81-CV-

10-365, 2014 WL 7476215, at *41 (emphasis added). Because neither party argues that

the tax court applied the incorrect analytical framework in this case, we assume, without

deciding, that it is the appropriate analytical framework.

       At trial, Guardian Energy relied primarily on two facts to support its proposed

33.3-percent reduction for each of the three years at issue—a 40-percent decline in

commercial market values generally and an industrywide decrease in the profit margins

of ethanol. Guardian Energy’s appraiser based his analysis in “significant measure” on

industrywide decreases in the profit margin on one gallon of ethanol caused by

10
       The tax court first applied the Eurofresh analytical framework for a taxpayer
claiming external obsolescence in American Crystal Sugar Co. v. County of Polk, No.
C1-05-574, 2009 WL 2431376, at *25 (Minn. T.C. Aug. 5, 2009), amended, No. C1-05-
574, 2009 WL 5064334 (Minn. T.C. Dec. 21, 2009).


                                             19
overcapacity, lower demand, and the increased price of corn. When Guardian Energy’s

ethanol plant was under construction in 2007 and 2008, the nationwide profit margin of

ethanol was forecasted to be approximately $1 per gallon. But between 2008 and 2011,

actual margins dropped by more than one-half nationwide, to $0.45. The tax court found,

however, that Guardian Energy’s ethanol margins “averaged $.666 per gallon across

2010 and 2011” and that Guardian Energy had admitted that its profit margins were

stronger than the national averages.

       The tax court rejected Guardian Energy’s reliance on commercial market values as

an appropriate measure of obsolescence because Guardian Energy failed to connect

industrywide trends to the subject property. The tax court reasoned that Guardian Energy

did not establish that the value of this particular plant declined simply because the

market value of other commercial properties declined. Moreover, relying on the 2004 tax

court decision in Pep Boys v. County of Anoka, the tax court determined that the price per

gallon of ethanol was not an appropriate indicator of external obsolescence because the

price of ethanol is a function of the “machinery and equipment” installed at the property,

which is not part of the taxable real property. See Guardian Energy, 2014 WL 7476215,

at *43 (citing Pep Boys v. Cty. of Anoka, No. C2-01-2780, 2004 WL 2436350, at *6

(Minn. T.C. Oct. 26, 2004) (concluding that “external obsolescence goes to the

improvements and/or land, not to the business that occupies the improvements and/or

land”)).

       For its part, the County proposed decreasing reductions for external obsolescence

of 45 percent, 35 percent, and 25 percent for the three assessment dates. The County’s


                                           20
appraiser based his estimates on four acquisitions of ethanol plants, all of which were

distressed sales by mortgagees who had taken back idling plants.          To estimate the

external obsolescence inherent in each transaction and to extrapolate it to Guardian

Energy’s facility, the County’s appraiser compared the price paid per gallon of capacity

to the cost of construction.      The County’s appraiser also cited overcapacity and

deteriorating profit margins as factors contributing to the property’s external

obsolescence, but the appraiser decreased the reduction for external obsolescence for

2010 and 2011, as sales of ethanol plants “clearly show[ed] an upward trend in prices

after early-to-mid 2009.”11 The tax court rejected this approach, concluding that the

County’s analysis of the comparable ethanol plant transactions failed to consider the

machinery and equipment included in the sales and the differences in market conditions,

location, and the quality of improvements.

       The tax court concluded that total ethanol production capacity in the United States

is the appropriate quantitative standard to measure external obsolescence. Guardian

Energy, 2014 WL 7476215, at *42. In making its calculation, the tax court relied on


11
       In its post-trial briefing, the County offered a different method of calculating
external obsolescence based on increasing utilization of ethanol plants industrywide. The
County’s appraisal evidence at trial indicated that “the number of idled plants in the U.S.
was reduced from 21 at the start of 2009, to 11 at the start of 2010. By January of 2011,
only one plant was reportedly idle.” As of January 1, 2009, 170 of 191 ethanol plants
were operating, which is a utilization factor of 89 percent. The utilization rates increased
to 94.5 percent and 99.5 percent in 2010 and 2011, respectively. Based on this increase,
the County argued that the tax court could use industrywide plant utilization rates as the
appropriate measures of external obsolescence for the years at issue, which amounted to
significantly lower levels of obsolescence —11 percent, 5.5 percent, and 0.5 percent for
the three years at issue. The tax court did not address this analysis in its findings.


                                             21
federally mandated ethanol blending requirements, drawn from data included in the

appraisal reports of both parties.   The tax court analyzed external obsolescence by

comparing the reported demand for ethanol in the United States with the reported ethanol

production capacity in the United States for each year. The tax court considered data in

the appraisal reports, which indicated that only about 84 percent of United States ethanol

production capacity could be used domestically in 2009, and about 92 percent in 2010.

This left 16 percent and 8 percent, respectively, of production capacity unused. The tax

court took these measures of unused production capacity—16 percent in 2009; 8 percent

in 2010—as the appropriate indicators of obsolescence in the ethanol industry in those

years and concluded that there was no evidence of unused production capacity in the

market in 2011. Because there was no evidence that Guardian Energy’s facility would

have had a different level of unused production capacity than the industry as a whole, the

tax court applied the level of unused United States production capacity as the measure of

the property’s external obsolescence—16 percent in 2009, 8 percent in 2010, and

0 percent in 2011.

                                            2.

      We conclude that the tax court’s calculation of external obsolescence is clearly

erroneous because it is not reasonably supported by the record as a whole. See 444

Lafayette II, 830 N.W.2d at 29; Equitable Life Assur. Soc’y of the U.S., 530 N.W.2d at

552. To be sure, we expect the tax court to “exercise its own skill and independent

judgment,” Eden Prairie I, 797 N.W.2d at 195, and we discourage the verbatim adoption

of a party’s market valuations, see id.; see also Lundell v. Coop. Power Ass’n, 707


                                           22
N.W.2d 376, 380 n.1 (Minn. 2006) (observing that when a court’s findings of fact and

conclusions of law are identical to the proposed findings and conclusions submitted by a

party, a reviewing court cannot determine the extent to which the lower court’s decision

was independently made); In re T.A.A., 702 N.W.2d at 707 n.2 (observing the same). But

these expectations do not allow the tax court to substitute its own measure of external

obsolescence that is without support in the record, while completely ignoring the record

evidence and the expert appraisal testimony.

       Here, the tax court failed to explain adequately why it selected the particular

measure of external obsolescence it used—applying capacity alone as a proxy for

external obsolescence—and whether such a methodology is an accepted approach.12

Indeed, with virtually no record support or explanation, the tax court based its entire

obsolescence calculation on capacity, while both parties’ experts considered capacity as

merely one element in the determination of external obsolescence. Moreover, without

any explanation, the tax court rejected entirely the decline in ethanol profit margins that

both parties’ appraisers found to be a primary consideration in determining external

12
        Perhaps by treating capacity as a proxy for external obsolescence, the tax court
intended to apply an “inutility” approach, which is a cost-to-capacity measurement of
obsolescence. Inutility, a generally accepted method of calculating obsolescence, is
estimated by comparing the property’s capacity to its use level and adjusting the result for
economies of scale. See John Corum, Inutility—an Approach to Calculating Economic
Obsolescence, J. Multistate Tax’n & Incentives, July 2009, at 22. Lower capacity
utilization results in lower property values. For example, “if a production facility has the
boilerplate capacity to manufacture 10,000 widgets a day, but can only produce 8,000
widgets daily due to market demand, a downward adjustment is made.” Robert D. Feder
& Anthony Festa, Application of the Cost Approach, in Valuing Specific Assets in
Divorce § 27.07 (2014), Westlaw VALSA.




                                            23
obsolescence.13 For a special-purpose property, it is impossible to divorce the property

value from the operations of the property itself for purposes of valuation because, by their

nature, special-purpose properties “typically have one practical use and no alternative

practical uses. In other words, only one type of business can operate within the special-

purpose property.” Robert F. Reilly, Measuring Economic Obsolescence in the Valuation

of Special-Purpose Properties, Am. Bankr. Inst. J., Sept. 2007, at 36. The tax court’s

disregard of declining profit margins is particularly confounding because the

capitalization of the income loss attributable to the negative market influences is a

generally respected approach to calculating external obsolescence. See Appraisal Inst.,

The Appraisal of Real Estate 635-37 (14th ed. 2013).


13
       Citing Pep Boys, the tax court determined that any consideration of increased corn
prices resulting in reduced profit margins should not be considered in the calculation of
external obsolescence. This reliance on Pep Boys was misplaced. The analysis in Pep
Boys is not readily applicable to a special-purpose property such as an ethanol plant. In
Pep Boys, the tax court addressed whether the taxpayer’s automotive center suffered from
obsolescence because its sales volume was lower than projected and did not support the
investment. 2004 WL 2436350, at *6. In that context, the tax court concluded that,
while external obsolescence can exist when the market where a property is located is
overbuilt and creates an excess supply of competitive properties, “a failure to meet sales
projections, does not, by itself, demonstrate that a property suffers from external
obsolescence.” Id.

        Here, in contrast, the tax court was valuing an ethanol plant, which is a special-
purpose property that requires corn to operate. Unlike an ethanol plant, “most
warehouses, office buildings, shopping malls and light to medium manufacturing plants
may have several alternative uses.” Robert F. Reilly, Measuring Economic Obsolescence
in the Valuation of Special-Purpose Properties, Am. Bankr. Inst. J., Sept. 2007, at 36, 36.
Thus, unlike a big-box retailer, or a store such as Pep Boys, a special-purpose property is
valued precisely for its use. That use necessarily implicates factors that would be specific
to the special-purpose property, such as, in this case, the cost of corn as it relates to profit
margins.


                                              24
      Although we question the tax court’s methodology, we acknowledge the complex

and unique valuation challenges in calculating external obsolescence. Thus, while we

conclude that a remand is necessary, we do not mandate a particular methodology to

apply on remand. Nor do we endorse either party’s obsolescence calculation. Indeed, it

appears that Guardian Energy did not adequately connect industrywide trends to the value

of the subject property. And our decision does not foreclose the possibility that the tax

court could properly adopt a methodology that is different from those advanced by either

party, if the tax court adequately explains its reasoning and if the evidence as a whole

supports the alternative methodology.

                                           IV.

      In sum, the absence of explanation supporting the tax court’s method of

calculating external obsolescence constrains our substantive review of the adequacy of

that methodology. See, e.g., Eden Prairie II, 830 N.W.2d at 24 (concluding “that the tax

court failed to explain why it fundamentally changed its capitalization methodology or

identify supporting appraisal testimony in the record for utilizing 6% of the effective tax

rate to load the capitalization rate”). Not only is the record devoid of expert-appraisal

support demonstrating that capacity, by itself, would be an appropriate method to

calculate obsolescence, but also the tax court failed to provide an adequate explanation of

its choice of methodology. We, therefore, conclude that the tax court’s valuation of the

ethanol plant was not reasonably supported by the record as a whole. Accordingly, we

vacate the tax court’s value determinations for 2009, 2010, and 2011, and remand for




                                            25
further proceedings consistent with this opinion. On remand, the tax court may, in its

discretion, reopen the record and conduct an additional evidentiary hearing.

      Affirmed in part, vacated in part, and remanded.

      LILLEHAUG, J., took no part in the consideration or decision of this case.




                                           26
