It’s official: The former downtown Toys “R” Us property will be the future home of a performing arts, conference and cultural center.

The decision came Tuesday in a series of four split Federal Way City Council votes. The city will purchase the 3.95-acre parcel at 31510 20th Ave. S. for $5.375 million, plus closing costs, from Pal-Do World Inc. A state grant will cover the majority of the acquisition costs. Street frontage and infrastructure improvements near the property will be added before the city takes on the full capital project sometime in the undetermined future.

Additionally, at the seller’s request, the city will issue a letter threatening to condemn the acreage and acquire it for a public use. This permits Pal-Do World Inc. to skirt federal taxes on the sale of the land for two years.

The topic of a performance center, which the city is now referring to as a civic center, drew a large crowd to the council’s regularly scheduled meeting. Fifteen residents publicly commented in support of the civic center. Several of the speakers are involved in the arts and expressed a need for a hometown place to perform. Others want to see Federal Way build something that creates a positive atmosphere that draws crowds and tourist dollars.

“I’d like to see Federal Way be a destination, not a convenience stop for coffee and gas,” resident Susan Weldon said.

Four residents speaking against the project were mostly concerned with costs.

“We can’t afford it,” Norma Blanchard said. “I’m totally against it at this point.”

State grant

The city council voted 6 to 1 to accept a $5 million state grant to use toward the purchase of the land. Councilman Jim Ferrell dissented. He has repeatedly said this is not the time to build a performance center in Federal Way.

Federal Way received the grant in 2008. It had until the end of this year to use, or lose, the money toward the purchase of property for a future performing arts center. By accepting the grant, the city has agreed to build a performance center on the former Toys “R” Us property by Dec. 31, 2020. If the facility is not constructed by this time, the city will reimburse the state $5 million plus interest.

The grant comes with stipulations. The city must make infrastructure and street frontage improvements near the future civic center site. Of the $5 million in state money, $100,000 will go toward this. The city will spend $214,000 to add street frontage improvements, including wider sidewalks, decorative streetlights and landscaping in the area by mid-2011.

Downtown Redevelopment funds

In addition to the $5 million in state money, the city plans to apply $437,000 from a previous state grant toward the property purchase. The remaining money needed to buy the land ($156,530) will come out of the city’s Downtown Redevelopment capital improvement projects fund. The council approved this measure in another 6-1 vote, again with Ferrell dissenting.

Threat of condemnation

For the second time, council members considered whether the city ought to send Pal-Do World Inc. a letter threatening to condemn the Toys “R” Us property. In November, Pal-Do World Inc. requested the city write the letter so that an IRS 1033 Exchange, which allows a property owner to defer federal capital gain taxes for up to two years, may be pursued following the sale of the Toys “R” Us property. Pal-Do World owners would not sell the land unless the letter was written, city attorney Pat Richardson said at that time.

Both council members and Richardson have publicly implied the city does not plan to follow through on condemning the property and is only writing the letter as a means to acquire the land. Some council members were not comfortable with the 1033 request in November, and continued to express concern Tuesday.

Ferrell said he has a problem with the city saying, via a letter, it plans to condemn the property, when that is not the case. Councilman Jack Dovey agreed. Both he and Ferrell voted against issuing the letter.

“I worry you’re bordering on fraud,” resident Matthew Jarvis said during public comment.

Issuing the letter will not put the city in legal danger, Richardson said. She consulted a real estate and two tax law experts for professional opinions on the matter before recommending the city council approve the letter.

“I’m comfortable what we’re doing is legal,” Richardson said.

University of Washington assistant professor Justin Marlowe, who specializes in state and local finance and economic development practices, agrees. At the core, the issue concerns economic development, Marlowe said. Writing the letter is taking advantage of the IRS system, but the practice is done often and is a legal loophole, he said.

“At the face of it, it certainly looks shady, but it is quite common,” Marlowe said. “Even though it violates the spirit of the tax law in place, it is legal.”

A local tax attorney who did not wish to be named said she recommends the city publicly announce it has changed its mind and will condemn the property. The issue could be legally interpreted in a variety of ways, and this measure would help ensure the city’s legal safety.

David Tucker III, an IRS spokesman, was unwilling to answer questions about how the federal government regards the practice. He was also unwilling to say whether the IRS investigates 1033 Exchange applications to determine whether there was ever an actual threat — versus a perceived one — of condemnation in place.

“The IRS does not publish its investigative protocols. We do not provide thresholds, tolerances or specific information on what will or will not trigger an audit. To do so would be counterproductive and encourage selective non-compliance with the law by individuals willing to present information that is not factual, stopping short of the point where it would result in an investigation,” Tucker said via e-mail.

The letter may be legal, but it could set up the city for undesired consequences. It conveys a message that the City of Federal Way is comfortable using eminent domain practices as a means to obtain private property and encourage economic growth, Marlowe said. This could lead to an atmosphere in which property owners feel it’s appropriate, when wanting to get rid of an undesirable property, to pitch it to the city for a public building, he said.

Property purchase

With three issues passing with a majority vote, the council then voted 5 to 2, with Dovey and Ferrell dissenting, to direct Mayor Skip Priest to execute the purchase and sale agreement with Pal-Do World Inc. The sale is expected to clear by the end of the year. Councilwoman Linda Kochmar reminded the audience that the city has 10 years to construct the civic center.

“All we’re doing right now is land banking,” she said.

Click here to read a November 2010 report on the land purchase.