When a state university system (the exempt party) is the LANDLORD and a non-exempt LLC is the TENANT building student housing on university land -- the reverse of the usual exempt-tenant/taxable-landlord setup -- does the construction still qualify as an exempt § 151.311 contract, and who can issue the exemption certificates down the contractor chain?

Plain-English summary

This ruling addresses the reverse fact pattern from the many "exempt tenant / taxable landlord" charter-school rulings elsewhere in this corpus — here the roles are flipped: the exempt party is the LANDLORD, and the taxable party is the TENANT.

An Alabama nonprofit foundation, whose mission is helping colleges provide student housing, controls a single-purpose Alabama LLC ("Lessee") formed specifically to help Tarleton State University get a new dorm built. The Texas A&M University System's Board of Regents — which owns the campus land — signed a 32-year ground lease with Lessee to develop, finance, build, and operate a 514-bed student housing facility limited to students, program participants, and university faculty/staff. Under the lease: title to the improvements stays with Lessee until the lease ends (or until the Board exercises its purchase option early); the Board must approve all construction plans, documents, and change orders; construction can't disrupt the Board's operations; and the University itself will manage the finished building as if it were ordinary on-campus housing. Financing runs through revenue bonds, and Lessee hired a Developer, who in turn hired a Contractor, to actually build it.

Six specific questions got a straightforward "yes, exempt" — but the more interesting part is why. Because the University System (the exempt § 151.309 governmental entity) is the LANDLORD, not the tenant, the well-known two-prong "primary use and benefit" test (exempt lessee + long lease term vs. improvement useful life) doesn't apply — that test is specifically designed for the opposite scenario (exempt tenant, taxable landlord). Instead, the Comptroller applied a broader facts-and-circumstances test, drawing on two prior rulings addressing this reverse scenario:

• A 2001 STAR letter involving another Texas university system's student housing, where a non-exempt lessee held a leasehold "for the exclusive benefit" of the university, with the university setting operating policies and holding a purchase option — held exempt even though title didn't transfer immediately.
• A 2006 Comptroller decision on an airport hangar locker room (exempt — city held title, public function) contrasted with a bathroom in the same hangar built by the tenant airline without city approval or title transfer (NOT exempt — insufficient proof of the city's control or benefit).

Weighing all the facts here — exclusive use restricted to eligible University-affiliated tenants, the Board's veto power over improvements and construction decisions, and the University's own management of the finished building — the Comptroller concluded the improvements are for the Board's primary use and benefit, even though legal title won't pass to the Board until the lease ends (delayed title transfer is a factor, but not dispositive on its own).

Practical result: Lessee may issue an exemption certificate to the Developer — but must do so in its OWN name, not as the Foundation's agent, since the Foundation itself isn't a party to the lease or later agreements. The Developer may pass exemption certificates to the Contractor and to its own suppliers, and the Contractor may do the same down its own supply chain.

What this means for you

Universities and their foundations structuring student-housing P3 deals

If your university system (the exempt entity) is the LANDLORD in a ground lease to a non-exempt developer/operator entity — rather than the more common setup where the university is the tenant — don't assume the familiar two-prong lease-term test applies. Build your record around a facts-and-circumstances case: exclusive use restrictions favoring the university, the university's approval rights over construction, and university control/management of the finished facility all matter, and delayed title transfer alone won't sink the exemption.

Foundations setting up single-purpose LLCs to support university housing

If your foundation isn't itself a party to the ground lease (only your controlled LLC is), make sure the exemption certificate is issued by the LLC in its own name — the Comptroller specifically corrected the taxpayer's assumption that the LLC could act "as agent" for the foundation here.

Developers and contractors on university-land P3 housing projects

Confirm where your project sits in the exemption-certificate chain: this ruling confirms a taxable Lessee-turned-Developer-turned-Contractor relationship can each pass exemption certificates down the line once the underlying ground lease itself qualifies as exempt.

Common questions

Q: If the exempt entity is the LANDLORD instead of the tenant, does the two-prong lease-term test still apply?
A: No, per this ruling — that test is designed for the opposite scenario (exempt tenant, taxable landlord); an exempt-landlord/taxable-tenant deal is instead evaluated under a broader facts-and-circumstances test.

Q: Does it matter that legal title to the improvements won't transfer to the university until the lease ends?
A: Not by itself, per this ruling — delayed title transfer is one factor in the facts-and-circumstances analysis, but it doesn't defeat the exemption where other factors (use restrictions, approval rights, university management) support it.

Q: Can a foundation's controlled LLC issue an exemption certificate "as agent" for the foundation?
A: Not per this ruling — since the foundation itself wasn't a party to the lease or later agreements, the Comptroller directed the LLC to issue the certificate in its own name instead.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.311 (Taxable Items Incorporated Into or Used for Improvement of Realty of an Exempt Entity)
• Tex. Tax Code § 151.309(5) (state universities as exempt political subdivisions)
• 34 Tex. Admin. Code Rule 3.291(a)(5) ("primary use and benefit" exempt-contract standard)
• 34 Tex. Admin. Code Rule 3.322(c)(5) (state universities as exempt organizations)

Cited prior guidance:

• STAR Document 200006420L (2000); STAR Document 9312L1283D02 (1993) — exempt-LESSEE / taxable-lessor scenarios applying the two-prong test (distinguished, not applicable here)
• STAR Document 200108598L (2001) — exempt-LESSOR / taxable-lessee student-housing scenario, facts-and-circumstances test, held exempt
• Comptroller's Decision No. 44,896 (2006) — airport hangar locker room (exempt, city held title) vs. bathroom (not exempt, no city approval/title) — illustrates the facts-and-circumstances approach

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201405903L

Original ruling text

May 9, 2014

RE: Private Letter Ruling # 132240020

Dear Mr. ****:

We issue this private letter ruling in accordance with Rule 3.1 in response to
your request for a private letter ruling dated August 7, 2013. We provide
guidance on the comptroller’s interpretation of the phrase “primary use and
benefit” as used in Rule 3.291(a)(5), which concerns the scope of the exemption
in Tax Code Section 151.311 for tangible personal property that is purchased
for use in the performance of a contract to improve realty for an organization
exempted under Tax Code Section 151.309, if the property is incorporated into
realty in the performance of the contract. It does not appear that the agency
has previously addressed the precise facts presented by this inquiry, though we
have addressed similar situations.

FACTS PRESENTED

The * Foundation (the “Foundation”) is an Alabama non-profit
corporation organized under Sections 501(a) and (c)(3) of the Internal Revenue
Code. Its express purpose is to provide housing for students at U.S. colleges
and universities, assist colleges and universities in securing or obtaining
such housing, and otherwise assisting or supporting such colleges and
universities. The Foundation is the sole and controlling member of
**, LLC (the “Lessee”), an Alabama limited liability company that does
not qualify as an exempt entity under Alabama law, for the sole purpose of
assisting Tarleton State University (the “University”) to provide housing for
its students by financing, developing, constructing, and/or operating a student
housing project for the exclusive benefit of the University, and to otherwise
assist Foundation in accomplishing its purpose.

The Board of Regents of the Texas A&M University System (the “Lessor”), the
owner of land on University’s campus, has entered into a ground lease agreement
(the “Lease”) with Lessee for the purpose of developing, financing,
constructing, furnishing, equipping, and operating a 514 bed student housing
facility for the use and benefit of its eligible tenants. The term “eligible
tenants” is defined in the Lease to mean students; persons attending a program
presented and conducted by the University or certain other organizations; or
University faculty/staff and their families. During the 32 year term of the
Lease, title to the improvements will be vested in Lessee until the termination
date when title will immediately vest in Lessor. Lessor retains broad
discretionary powers relating to the provision of improvements, as further
explained in this ruling.

The Lease requires Lessee to enter into a development agreement with DEVELOPER.
The development agreement requires DEVELOPER to develop, construct, design,
equip, and furnish the student housing facility and various related amenities
and improvements. The Lease also requires DEVELOPER to enter into a
design/build contract with CONTRACTOR, an affiliate of DEVELOPER. This
contract requires CONTRACTOR to perform, or cause to be performed all design,
abatement, demolition and construction services, and to provide all material,
equipment, tools and labor, necessary to complete the facility. Lessor must
review and approve the construction documents—which by definition include the
development agreement and the design/build contract—and the plans and
specifications. Lessor must approve any change orders and all construction
activities must be done in a way that minimizes disruption of Lessor’s
operations. The Foundation has appointed Lessee as its agent for the sole
purpose of issuing an exemption certificate to DEVELOPER.

Finally, the Lease requires that Lessee operate or cause to be operated, all
improvements for the benefit of the University. In a management agreement
between Lessee and University, Lessee appointed University to be manager and to
operate the facilities in accordance with the Lease and applicable bond
document provisions. The Lease states that the parties and the University
intend the student housing facility to be treated the same as the University’s
other on-campus housing and outlines responsibilities of the University and
Lessor to that effect.

Funding will be met through the issuance of revenue bonds pursuant to the terms
of a Trust Indenture. Throughout the terms of the Lease, Lessor has the right
and option to purchase Lessee’s interest in the premises for the balance of the
outstanding loans, plus any required premiums, all interest due and payable and
any other charges due and payable under the bond documents. Also, during the
term of the Lease and for certain consideration, the University is deemed to be
a member of the Foundation.

RULINGS AND ANALYSIS

The rulings you specifically requested are shown below, followed by our
responses and analysis.

(1) The development agreement between Lessee, which is not an exempt entity,
and DEVELOPER is an exempt contract, given that it is a contract to improve
real property for the primary use and benefit of the University, an exempt
entity.

Response: The development agreement between Lessee and DEVELOPER is an exempt
contract, given that it is a contract to improve real property for the primary
use and benefit of an exempt entity and any tangible personal property
purchased for incorporation into the real property or completely consumed in
the construction of the facility is exempt from Texas sales or use tax.

(2) CONTRACTOR’s purchases of tangible personal property to be incorporated
into or completely consumed in the construction of the student housing facility
are exempt from sales and use tax.

Response: Agreed.

(3) Lessee, as an agent of Foundation, may properly issue an exemption
certificate to DEVELOPER.

Response: Lessee may issue an exemption certificate to DEVELOPER, but should do
so in its own name, not as an agent of Foundation.

(4) DEVELOPER may properly issue an exemption certificate to CONTRACTOR.

Response: Agreed.

(5) DEVELOPER may properly issue an exemption certificate to its vendors and
suppliers for tangible personal property incorporated into the student housing
facility in the performance of the contract.

Response: Agreed.

(6) CONTRACTOR may properly issue an exemption certificate to its vendors and
suppliers for tangible personal property incorporated into the student housing
facility in the performance of the contract.

Response: Agreed.

Section 151.311, Texas Tax Code, provides, in part, that the purchase of
tangible personal property for use in the performance of a contract for an
improvement to realty for an organization exempted under Section 151.309 is
exempt if incorporated into realty in the performance of the contract. Section
151.309 provides that taxable items sold, leased, or rented to, or stored,
used, or consumed by certain governmental entities are exempt. State
universities are considered exempt as political subdivisions of the state under
Section 151.309(5) and Rule 3.322(c)(5). Rule 3.291(a)(5) defines an exempt
contract as a contract for the improvement of real property with an entity that
is exempt under Section 151.309 or 151.310. An example of an exempt contract
is a contract with a nonexempt entity to improve real property for the primary
use and benefit of an organization exempted under Section 151.309. See Rule
3.291(a)(5). Although the phrase “primary use and benefit” has been used in
Rule 3.291 for many years, it has not been defined by rule. In addition, the
agency has employed different tests to determine if a contract meets the
“primary use and benefit” requirement of the rule. Therefore, it is arguably
unclear why the agreements at issue here qualify as exempt under Rule
3.291(a)(5).

There is no question that the development agreement and design/build contract
involve the incorporation of tangible personal property for the improvement of
real property. There is no question that the Lessor is an exempt organization
under Section 151.309. The issue to be decided is whether the improvements to
real property contemplated by the agreements are for the use and benefit of the
Lessor, an exempt organization, or the Lessee, a nonexempt organization.

The agreements stem from the ground lease entered into by the Lessor for the
express purpose of building a student housing facility. As described in the
statement of facts, the Lease contains several indicia that the improvements
are for the benefit of the Lessor and its member University. For example, the
Lease recitals state that the parties agree that the property shall be held for
the benefit of the University and will not be rented to provide private
residential housing to members of the public other than to eligible tenants.
Further provisions prohibit Lessee from making any capital improvements without
Lessor’s written approval. Lessor must review and approve all construction
related matters. Finally, the University will serve as manager of the
facility.

The agency has issued taxability letters that address contracts involving
improvements to real property between Section 151.309 exempt entities and
nonexempt entities. Some of those letters involved situations where the lessee
was the exempt entity and the lessor was the taxable entity. See, e.g., STAR
Documents 200006420L (June 21, 2000) and 9312L1283D02 (Dec. 29, 1993). In
reaching its ruling in STAR Document 200006420L, the agency cited two past
hearings, Nos. 28,391 (1993) and 31,505 (1994), stating that those two cases
set out the then newly adopted two-prong test used to determine whether the
exempt entity (lessee) or the taxable entity (lessor) has the “primary use and
benefit” of services purchased by the taxable entity to remodel leased
facilities. The first prong “is that the lessee must be an ‘exempt entity’
(under 151.309 or 151.310) and the second prong is that ‘the lease should be
long-term (in reasonable relationship to the life of the improvements
themselves)’.” However, this two-prong test is not applicable to the matter at
issue because the lessor is the exempt entity and the lessee is the taxable
entity.

The agency has issued at least one opinion in which the exempt entity was the
lessor and the taxable entity was the lessee. See STAR Document 200108598L
(August 20, 2001). The question of taxability did not specifically turn on a
restatement of the two-prong test. Instead, it seemed to turn on an analysis
of all the facts and circumstances, including the fact that the contract was
sought by the exempt entity (lessor, a public university) in furtherance of its
lawful purpose, which it could not undertake without the services provided by a
separate entity that was not exempt from tax.

In STAR Document 200108598L, it was determined that a non-exempt entity holding
a leasehold interest in property operated for the exclusive use and benefit and
in furtherance of the purposes of an exempt entity could properly issue an
exemption certificate to contractors performing work on the property. In that
matter, the board of regents for another Texas university system entered into a
lease agreement with a non-exempt entity that required the non-exempt entity to
hold its leasehold interest in the dormitory facilities for the exclusive
benefit of the university. That lease agreement was similar to the lease at
hand in that the lease involved student housing, and that housing was strictly
limited to students attending the university. That lease also indicated that
the university and its board set forth the general guidelines underpinning the
rules, regulations and policies of the lessee. Also, the board was an active
participant in management policies. Finally, the board retained the option to
purchase the leasehold interest and related equipment at any time. One key
difference is that title to the improvements in that lease was conveyed to the
university system immediately.

The agency determined, based on the statement of facts in STAR Document
200108598L, that so long as the dormitory facilities were being used in support
of the board of regents and the university and in support of their functions,
then any work done on the facilities was for the direct benefit of the board
and the university. Accordingly, that work was deemed to be exempt and the
non-exempt entity was permitted to issue an exemption certificate to any
contractors performing the work.

Similarly, in Comptroller’s Decision No. 44,896 (2006), the comptroller once
again employed a facts and circumstances test and determined that improvements
to a locker room in an airport hangar leased by a private airline from CITY A
were for the primary use and benefit of the exempt entity because the hangar
served a public function and the improvements qualified for exemption. In that
instance, the City held title to the facilities. In the same decision,
improvements to a bathroom in an airport terminal were found not to be exempt.
The improvements had been built by the lessee airline on land owned by the
City. Title to the facilities remained with the airline and the improvements
were not subject to approval by the airport. The comptroller determined that
there was insufficient proof to grant the exemption.

The facts presented in this request indicate that title to the improvements
will not pass to the exempt entity until the conclusion of the Lease, unless
the Lessor exercises its option to purchase them before that time. However,
this factor is not dispositive in the face of all the previously discussed
factors which support the conclusion that the facilities are being constructed
for the primary use and benefit of the exempt entity.

Using a facts and circumstances test, there is no question that the Lessor will
derive the primary use and benefit from being able to have on-campus housing
available for its students, and that there would be no new on-campus housing
unless this venture is undertaken.

Thus, because the development agreement is an exempt contract, Lessee may
properly issue an exemption certificate to DEVELOPER. However, Lessee should
issue the exemption certificate in its own name, since Foundation is not a
party to the Lease or subsequent agreements. CONTRACTOR’s purchases of tangible
personal property to be incorporated into or consumed in the construction of
the facility are also exempt. DEVELOPER may issue an exemption certificate to
CONTRACTOR and to its own vendors and suppliers under Section 151.309.
CONTRACTOR may issue an exemption certificate to its vendors and suppliers
pursuant to Section 151.311.

If you have questions about this private letter ruling, please email us at
https://www.window.state.tx.us/taxhelp/ and reference Private Letter Ruling

132240020.

Sincerely,

Tax Policy Division