Applying Texas Sales and Use Tax to New Construction and Real Property Repair and Remodeling Services

Applying Texas Sales and Use Tax to New Construction and Real Property Repair and Remodeling Services

One of the more complicated areas involving Texas sales and use tax is the taxation of various new construction and real property repair and remodeling services.[1] Determining what’s taxed and what’s not requires delving through myriad definitions scattered across the Texas Tax Code and Comptroller’s rules. It can get confusing fast. Here’s a quick breakdown.

What’s a “Contractor”?

Let’s get this out of the way up front. When the Comptroller says “contractor,” it may not mean what you think it means. The term “contractor” as used for purposes of the Texas sales and use tax is a term of art.  The term is defined as:

Any person who builds new improvements to residential or nonresidential real property, completes any part of an uncompleted new structure that is an improvement to residential or nonresidential real property, makes improvements to real property as part of periodic and scheduled maintenance of nonresidential real property, or repairs, restores, maintains, or remodels residential real property, and who, in making the improvement, incorporates tangible personal property into the real property that is improved.[2]

Notice what the term doesn’t cover: nonresidential repair and remodeling. That’s because while new construction and residential repair or remodeling aren’t taxable services, nonresidential repair and remodeling is a taxable service and subject to Texas sales and use tax.[3]

This is important, because the Comptroller uses the designation “contractor” as a way to distinguish between taxable and nontaxable construction services. This can cause considerable confusion to those new to the Comptroller’s rules, since the Comptroller has one rule for contractors (i.e., persons who perform new construction and residential repair and remodeling) and one rule for nonresidential repair and remodeling (let’s call them “service providers”).[4]

New Construction vs. Repair or Remodeling

The first thing to ask in determining the taxability of construction services is whether what is being performed is 1) new construction or 2) repair or remodeling.

“New construction” is defined as:

All new improvements to real property, including initial finish-out work to the interior or exterior of the improvement. An example is a multiple story building that has had only its first floor finished and occupied. The initial finish-out of each additional floor before initial occupancy or use is new construction. New construction also includes the addition of new usable square footage to an existing building. Examples include the addition of a new wing onto an existing building. Reallocation of existing square footage inside a building is remodeling and does not constitute the addition of new square footage. For example, the removal or relocation of interior walls to expand the size of a room or the finish out of an office space that was previously used for storage is remodeling. Raising the ceiling of a room or the roof of a building is not new construction if new usable square footage is not created.[5]

On the other hand, “repair” is defined as “[t]o mend or bring back real property that was broken, damaged, or defective as near as possible to its original working order.”[6]  “Remodeling” means “[t]o rebuild, replace, alter, modify, or upgrade existing real property.”[7]

As can be seen through these definitions, the primary factors in determining whether a job is new construction are whether the structure has already been occupied and, if so, whether new usable square footage is created.  If the structure has not already been occupied and the work performed is an initial finish-out, then the work would probably be considered new construction.[8]  If the structure has been occupied but the work creates new usable square footage, the work again probably would be considered new construction.[9] If neither one of these factors applies, the work likely will be considered repair or remodeling.

Again, nonresidential repair and remodeling is a taxable service, while residential repair and remodeling is not a taxable service. So, the next thing to ask whether the real property is residential or nonresidential.

Residential vs. Nonresidential

“Residential property” means:

Property that is used as a family dwelling, a multifamily apartment or housing complex, nursing home, condominium, or retirement home. The term includes homeowners association-owned and apartment-owned swimming pools that are for the use of the homeowners or tenants, laundry rooms for tenants’ use, and other common areas for tenants’ use. The term does not include hotels or any other facilities that are subject to the hotel occupancy tax.[10]

Nonresidential real property is not defined, so apparently any property that is not residential real property is nonresidential real property.

Taxability of Nonresidential Repair or Remodeling

If a job is purely nonresidential repair or remodeling, then the tax treatment is clear. The total charge (less separately stated charges for unrelated services) is taxable unless an exemption applies.[11]  The service provider generally would be able to issue a resale certificate to vendors for materials that are incorporated into the realty as part of the service.[12]

Taxability of New Construction and Residential Repair or Remodeling

If a job is new construction or residential repair and remodeling, an additional question must be asked: Is the contract lump sum or separately stated?[13]

A contract is lump sum if “the agreed contract price is one lump-sum amount and in which the charges for incorporated materials are not separate from any charges for skill and labor, including fabrication, installation, and other labor that the contractor performs.”[14]

On the other hand, a contract is separately stated if “the agreed contract price is divided into a separately stated agreed contract price for incorporated materials and a separately stated amount for all skill and labor that includes fabrication, installation, and other labor that is performed by the contractor.”[15]

“Incorporated materials” are defined as:

Tangible personal property that becomes a part of any building or other structure, project, development, or other permanent improvement on or to such real property including tangible personal property that, after installation, becomes real property by virtue of being embedded in or permanently affixed to the land or structure constituting realty and which property after installation is necessary to the intended usefulness of the building or other structure.[16]

So, turning at last to the taxability of new construction and residential repair or remodeling, if the contact for such work is lump sum, then no part of the charge generally is taxable, but the contractor must pay tax on the materials purchased for the job.[17]  If the contract for such work is separately stated, then the contractor must collect tax on charges for incorporated materials (unless an exemption applies), but may be able to issue a resale certificate to vendors on its purchase of such materials.[18]

Conclusion

Still confused? Here’s a chart that sums up the taxability of new construction, residential repair and remodeling, nonresidential repair and remodeling under the Texas sales and use tax:

And, of course, if you have any questions regarding the Texas sales or use tax or Texas taxes in general, don’t hesitate to give us a call to schedule a free consultation. 

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[1] Part of the complexity in this area is due to history, that nightmare from which we’re trying to awake.  Prior to 1988, contracting and repair services generally weren’t taxable. See Acts 1987, 70th Leg., 2nd C.S., ch. 5, art. 1, pt. 4, Sec. 12 (adding real property repair and remodeling as a taxable service effective January 1, 1988). However, separately stated charges for materials incorporated into realty as a result of such services even then were subject to tax.  See Acts 1981, 67th Leg., p. 1551, ch. 389, Sec. 1 (distinguishing between the taxability of separated and lump sum contracts for contractors). As we’ll see, this treatment continues for new construction and residential repair and remodeling. Nonresidential repair and remodeling (and maintenance, which we won’t discuss in this post) could just be considered an exception to this rule.

[2] 34 Tex. Admin. Code §§ 3.291(a)(3); see also 34 Tex. Admin. Code § 3.357(a)(2); accord Tex. Tax Code § 151.056(d) (defining “contractor” as a person who makes an improvement on real estate and who, as a necessary or incidental part of the service, incorporates tangible personal property into the property improved.”).

For these purposes, an “improvement to real property” is defined as work to:

• erect, construct, alter, or repair any building or other structure, project, development, or other permanent improvement on, under the surface of, or to real property, whether fee or leasehold;
• furnish and install property becoming a part of any building or other structure, project, development, or other permanent improvement on or to such real property, including tangible personal property, which after installation becomes real property by virtue of being embedded in or permanently affixed to the land or to a structure constituting realty and which property after installation is necessary to the intended usefulness of the building or other structure; or
• alter the land surface of real property by such means as creating roads, earthen dams, and stock tanks. However, mining or timber operations do not, in and of themselves, constitute improvements to realty.

See 34 Tex. Admin. Code §§ 3.291(a)(6), 3.347(a).

Generally, the question of whether tangible personal property has been affixed to realty so as to become an improvement to realty is determined by reference to the test set forth by the Texas Supreme Court in Hutchins v. Masterson, 46 Tex. 551 (1887).  See, e.g., Comptroller’s Decision No. 112,152 (2018).  Under this test, one asks three questions:

1. Has there been a real or constructive annexation of the article in question to the realty?
2. Was there a fitness or adaptation of such article to the uses or purposes of the realty with which it was connected?
3. Was it the intention of the party making the annexation that the chattel becomes a permanent accession to the freehold?

Id.

[3] See Tex. Tax Code §§ 151.0047(a), 151.0101(a)(13); 34 Tex. Admin. Code § 3.357(b)(2).

[4] See 34 Tex. Admin. Code §§ 3.291 (entitled “Contractors” and covering new construction and residential repair and remodeling), 3.357 (entitled “Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance. (Tax Code, §§151.0047, 151.0101, 151.056, 151.058, 151.311, 151.350, 151.429)” and covering periodic and scheduled nonresidential real property maintenance but referring back 34 Tex. Admin. Code § 3.291 when tangible personal property is incorporated into realty as part of such maintenance).

[5] 34 Tex. Admin. Code § 3.291(a)(9); see also 34 Tex. Admin. Code 3.357(a)(8) (stating that “new construction” also includes “the addition of a new mezzanine level within an existing building”).

[6] 34 Tex. Admin. Code § 3.357(a)(12).

[7] 34 Tex. Admin. Code § 3.357(a)(11).  Repainting is also remodeling, as is the partial demolition of existing nonresidential real property. Id.  However, a complete demolition isn’t remodeling and is nontaxable. Id.

[8] See 34 Tex. Admin. Code §§ 3.291(a)(9), 3.357(a)(8).

[9] Id.

[10] 34 Tex. Admin Code § 3.291(a)(12); see also 34 Tex. Admin. Code § 3.357(a)(13) (adding that “residential property” doesn’t include “any commercial area open to nonresidents, retail outlets, [or] hospitals”).  “Prisons” also may not be residential property. See The Geo Group, Inc. v. Hegar, No. 03-15-00726-CV (Tex. App.—Austin Aug. 10, 2017, pet. denied) (holding that a prison was a not a residence for purposes of the exemption for the purchase of natural gas and electricity for residential use under Tex. Tax Code § 151.317).

Note that the term “residential property” also doesn’t include “facilities that are subject to hotel occupancy the tax.”  34 Tex. Admin. Code §§ 3.291(a)(12), 3.357(a)(13).  This creates some uncertainty as to whether houses used for short term rentals are residential property, since short term rentals generally subject to hotel occupancy tax.  See Tex. Tax Code §§ 156.001(b) (stating that the term “hotel” includes a short-term rental, and that a “short-term rental” is “the rental of all or part of a residential property to a person who is not a permanent resident . . . .”), 156.051(a) (imposing a tax on a person who pays for the use or possession of a room or space in a hotel).

[11] 34 Tex. Admin. Code § 3.357(b)(2). A service is unrelated if it: 1) is not nonresidential repair or remodeling or any other taxable service, 2) is of a type that is commonly provided on a stand-alone basis, and 3) is distinct and identifiable. Id. § 3.357(a)(15).

[12] 34 Tex. Admin. Code § 3.357(e)(1).

[13] While the distinction between lump-sum and separately stated contracts used when determining the taxability of nonresidential repair and remodeling (presumably before nonresidential repair and remodeling was made a taxable service), it generally is no longer relevant for that purpose. See 34 Tex. Admin. Code § 3.357(b)(2). However, the distinction is still relevant in certain contexts. For example, “labor to repair real or tangible personal property that is damaged within a disaster area by the condition or occurrence that caused the area to be declared a disaster area is exempt from tax if the charge for labor is separately stated to the customer. The materials that are used to perform the repairs are taxable.”  34 Tex. Admin. Code § 3.357(d)(9).

[14] 34 Tex. Admin. Code § 3.291(a)(8).

[15] Tex. Tax Code § 151.056(b); 34 Tex. Admin. Code § 3.291(a)(13).

[16] 34 Tex. Admin. Code § 3.291(a)(7).

[17] See Tex. Tax Code § 151.056(a); 34 Tex. Admin. Code § 3.291(b)(3)(A).

[18] See Tex. Tax Code § 151.056(b); 34 Tex. Admin. Code § 3.291(b)(4)(A), (B).