THE FUNDAMENTALS OF A TAX INCREMENT REINVESTMENT ZONE (TIRZs) - content updated October, 2020
By Brian O'Connor, Economic Development Specialist
Tax Increment Financing (TIF) is a tool that incentivizes/stimulates economic development. Chapter 311 of the Texas Tax Code authorizes local governments to designate special zones to attract new investment to an area. Tax Increment Reinvestment Zones s help finance the cost of redevelopment and encourage development in an area that would otherwise not attract sufficient market development in a timely manner. Taxes attributable to new improvements (tax increments) are set-aside in a fund to finance public improvements within the boundaries of the zone.
The tax increment is the difference in appraised value between the year in which the reinvestment zone is established (base year) and each year the reinvestment zone is in existence.
Who Establishes Tax Increment Financing and Creates a Tax Increment Reinvestment Zone?
A municipality municipality establishes a TIF zone. Other taxing entities may choose to contribute by approving a participation agreement that establishes on a case-by-case basis the percentage (0 percent to 100 percent) of incremental tax revenue they will contribute to the fund.
Under Section 311.005 a taxing unit, city, county, water district, school district, is not required to pay into the tax increment fund any of its tax increment produced from property located in a reinvestment zone unless the taxing unit’s governing body enters into an agreement with the governing body of the municipality that created the zone.
A board of directors, consisting of 5 to 15 members representing each participating taxing entity is established for each TIF zone.
How does a tax increment grow?
There are two ways that tax increment can grow: through new development and via yearly increases in property value. If a developer constructs a $2 million building, the property taxes from the $2 million value are deposited into a TIRZ account. And if a $100 million TIRZ grows in value by 3 percent, then property taxes generated by the $3 million increase in value are also added to a TIRZ fund.
In a TIRZ, the taxes on the increase in property values are set aside to finance specific public improvements in the zone. All taxing entities continue to receive tax revenue on the original value of the property. The tax on the increased value of the property, after development, is the tax increment. No participating taxing entities experience a reduction in the level of tax revenues they are currently receiving.
What happens to the money?
Oftentimes, municipalities take the promise of the tax increment to the bond market to raise money for street, sewer, traffic, or other public infrastructure improvements to support a specific development. Support may take the form of contributing cash to the developer's cost as an incentive to do the project or allow the developer to make a reasonable profit in a challenging environment.
Some governments adopt a “pay as you go” approach, avoiding indebtedness altogether by allowing tax increment revenues to accumulate before a project is begun. Developers of larger public projects sometimes will agree to front infrastructure costs if they are reimbursed over the TIF term. The pay as you go model can shift debt risk to developer; however, it can be a slow process depending upon the rate of zone development.
How does a TIRZ get created?
Defining the zone’s geographical boundaries is the first step in creating a TIRZ. To establish a baseline, the assessed values of properties in the TIRZ are frozen, and any taxes on the increased value during the zone’s term are captured as TIRZ revenue.
Usually, only governmental entities can designate a TIRZ area. In Texas, however, owners of properties constituting at least 50 percent of the appraised property value in the proposed district may petition for the creation of a TIRZ. This allows private owners-developers to initiate creation of a district rather than depending on a city.
The petitioner is only required to submit a preliminary development and finance plan before the TIRZ is established. Plans are sent to the local taxing units with notice of a public hearing on the proposed zone and a request that representatives meet with the city. The city then makes public presentations to the zone’s taxing units informing them on the plan.
At the hearing, the taxing units evaluate the zone’s proposed benefits, and the public is allowed to comment. Once these preconditions have been satisfied, regardless of the outcome, the city can pass an ordinance establishing the zone and its governing board.
Afterwards, the governing board must execute a final financing plan that includes the following:
• A detailed list of estimated project costs;
• A list of all proposed public works or improvements within the zone;
• An economic feasibility study;
• The estimated amount of bonded indebtedness to be incurred;
• The timing for incurring costs or monetary obligations;
• The methods for incurring all estimated project costs and the expected sources of revenues, including the percentage of tax increment to be derived from the property tax of each taxing unit;
• The current total appraised value of taxable real property in the zone;
• The estimated captured appraised value of the zone during each year of its existence; and
• The duration of the zone.
The final plan is to be as consistent as possible with the preliminary plans developed for the zone before the creation of the board. Voter approval is not required to implement a TIF.
To be an effective economic development tool, a TIF area needs to be a win-win situation for the public and private sectors. In a time of strained government budgets, public investment is not always possible. Using TIF to allow the private sector to undertake community redevelopment projects is oftentimes the best alternative.