If a charter school already holds legal title to its land but ground-leases it to a landlord entity for construction financing, then leases back the remodeled/expanded campus, does the § 151.311 construction exemption still apply?

Plain-English summary

A Texas nonprofit charter-school operator had a new facility built at its own site — part of it an existing building that was remodeled into a school rather than ground-up new construction. Unusually, the school itself already held legal title to the land. To finance the build, it granted a ground lease to a single-purpose "Landlord" entity created just to hold the property for lease-back purposes, then entered a 30-year build-to-suit lease with that same Landlord for the finished Campus.

Applying its standard two-prong test under § 151.311, the Comptroller found the lease exempt:

1. Is the lessee a qualified exempt entity? Yes — the school is exempt under § 151.310.
2. Is the lease term long enough relative to the improvement's useful life? The 30-year lease term exceeds the campus's 22-year expected useful life (the school's own figure, from the state's capital-asset depreciation guide), so yes.

The fact that the school already owned the underlying land — and used a ground-lease/leaseback structure purely to route financing through a landlord entity, rather than because it lacked ownership — didn't change the result. The remodel-of-an-existing-building element also didn't matter to the analysis, which focuses on the lease term vs. useful life of the improvements, not on whether the structure was new construction or a remodel.

What this means for you

Charter schools that already own their land but need construction financing

Owning the underlying land doesn't take you outside § 151.311's construction exemption — a ground-lease/leaseback structure used purely to bring in a financing landlord still qualifies, as long as the exempt entity's ultimate lease term clears the useful-life bar.

Schools remodeling existing buildings rather than building new

This ruling confirms the exemption isn't limited to ground-up new construction — remodeling part of an existing building into a school campus qualifies the same way, under the same two-prong test.

Related rulings

This is one of a same-day (September 1, 2015) batch of build-to-suit charter-school lease rulings applying the identical two-prong test. It's distinguished from its companions by the school already holding legal title and using a ground lease (rather than a straightforward landlord-owned-fee-simple structure), and by involving a partial remodel of an existing building rather than pure new construction.

Common questions

Q: Does owning the land yourself disqualify you from the § 151.311 leaseback exemption?
A: Not per this ruling — the Comptroller looked at the ultimate lease term the exempt entity holds under the leaseback, not at who originally owned the underlying land.

Q: Does remodeling an existing building qualify the same way as new construction?
A: Per this ruling, yes — the analysis turns on the lease-term-vs-useful-life test, not on whether the improvements are new construction or a remodel.

Q: What lease term is long enough to satisfy the "primary use and benefit" test?
A: There's no fixed bright line — per this ruling, a 30-year lease against a 22-year useful life was sufficient, while a 5-year lease against a longer useful life failed in a prior cited decision.

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 § 151.310 (Religious, Educational, and Public Service Organizations)
• 34 Tex. Admin. Code Rule 3.291(a)(5) (Contractors — exempt-contract definition)
• 34 Tex. Admin. Code Rule 3.1; Rule 3.10 (Taxpayer Bill of Rights — detrimental reliance)
• 34 Tex. Admin. Code Rule 3.325 (Refunds and Payments Under Protest)

Cited prior guidance:

• Comptroller's Decision No. 28,391 (1993) — source of the two-prong "primary use and benefit" test
• Comptroller's Decision No. 31,505 (1994) — contrasting failure: 5-year lease term too short relative to improvements' useful life

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201509413L

Original ruling text

September 1, 2015

RE: Private Letter Ruling # 150970893

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1 in response to
your request dated April 2, 2015. Detrimental reliance is provided in
accordance with Rule 3.10, the Taxpayer Bill of Rights.

You requested guidance on the ’ interpretation
of the exemption in Texas Tax Code Section 151.311 for tangible personal property
and taxable services purchased for use in the performance of a contract to improve
real property for an organization exempt under Tax Code Section 151.310. The
Comptroller’s office has addressed similar facts presented by this inquiry; most recently
in other private letter rulings, particularly STAR DOCUMENT NOS. 201411982L,
201411981L, 201411980L, and 201409958L, all issued in 2014. However, we issue
this private ruling because guidance on this issue is not expressly provided in statute
or agency rule.

Relevant Facts Presented

**, formerly known as *, is a Texas non-profit corporation
granted tax-exempt status by the Internal Revenue Service pursuant to Section
501(c)(3) of the Internal Revenue Code. In addition, **** met the
qualifications for exemption from Texas Sales or Use Tax outlined in Rule 3.322
(Exempt Organizations).

** received a charter from the Texas Education Agency to operate an
open-enrollment charter school. * had a new facility constructed at
****, CITY, Texas, a portion of which was an existing building that was
remodeled to convert it into a school (“Campus”).

Legal title to the property is held by **; however, *
granted a ground lease to * (“Landlord”), a single purpose entity
created to hold the property for lease-back to * as the tenant. To
finance the construction of the Campus, * then entered into a
build-to-suit lease (“Lease”) [ENDNOTE 1] with Landlord where Landlord agreed
to construct the Campus per *’s specifications and to lease the
Campus to **** for an initial term of thirty (30) years.

Under the Lease, Landlord is required to implement a construction program to
build the Campus to **’s specifications, with the cost incorporated
into the Lease and paid for by * in monthly payments. The Lease
requires Landlord to make all of the improvements described within the exhibits
to the Lease. The Campus is being improved for, leased by, and used exclusively
by **** as an open-enrollment charter school. Texas Education Code
Section 12.105 states that an open-enrollment charter school is part of the
Texas public school system.

** receives its funding from the State of Texas (“State”) through a
funding system known as the Foundation School Program as authorized by Texas
Education Code Section 12.106. ** used state funds to lease the
Campus. Texas Education Code Section 12.128 states that property, whether
purchased or leased, is considered public property for all purposes allowed by
state law and is deemed to be state property held in trust by the charter
holder for the benefit of the students and may be used only for a purpose for
which a school district may use school district property.

The charter holder—in this case, ** —holds the state-owned property in
trust for the benefit of the attending students. If ** closes or
ceases to exist, the Texas Commissioner of Education, on behalf of the State,
takes immediate possession and assumes control over the property, including
leasehold rights under Texas Education Code Section 12.128(c)(1).

Requested Ruling and Analysis

Our restatement of the ruling you requested is shown below, followed by our
response and analysis.

Is the build-to-suit lease at issue an exempt contract as contemplated by Texas
Tax Code Section 151.311, thereby allowing the tax-free purchase of taxable
items by the taxable entity for incorporation into property leased by the
tax-exempt entity?

Response: This question is not addressed by statute or rule and the response
provided will be memorialized in a future amendment to Rule 3.291 (Contractors).
The build-to-suit lease at issue is an exempt contract as contemplated by Texas Tax
Code Section 151.311 because it is a contract to improve real property for the primary
use and benefit of an exempt entity. Tangible personal property or taxable services
meeting the requirements expressed in Texas Tax Code Section 151.311 are exempt
from Texas Sales or Use Tax.

Texas Tax Code Section 151.311 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 Texas Tax Code Sections 151.309 or
151.310 is exempt if the tangible personal property is incorporated into realty
in the performance of the contract. Texas Tax Code Section 151.311 further
provides that the purchase of a taxable service for use in the performance of a
contract for an improvement to realty performed for such an organization is
exempt if the service is performed at the job site and if the contract
expressly requires the specific service to be provided or purchased by the
person performing the contract or the service is integral to the performance of
the contract.

Rule 3.291(a)(5) defines an exempt contract to include a contract for the
improvement of real property with an entity that is exempt under Texas Tax Code
Section 151.309 or 151.310. The Rule further provides that an example of an
exempt contract is a contract with a non-exempt entity to improve real property
for the primary use and benefit of an organization exempted under Section
151.309 or 151.310.

For situations involving an exempt lessee and a non-exempt lessor, the
Comptroller’s office developed a two-prong test to determine whether
improvements to real property are for the primary use and benefit of the exempt
entity. The test was first set forth in COMPTROLLER’S DECISION NO. 28,391
(July 7, 1993), STAR DOCUMENT NO. 9307H1248D05.

First, the lessee must qualify for exempt status under Texas Tax Code Section
151.309 or 151.310. Based on the facts presented, ***** is a qualified
tax-exempt entity under Section 151.310; therefore, it meets the first prong of
the test.

Second, the term of the lease must be sufficiently long in relationship to the
life of the improvements themselves. This test has been consistently applied
by the Comptroller. See for example, COMPTROLLER DECISION NO. 31,505 (April 20,
1994), STAR DOCUMENT NO. 9404H1297E01, which found extensive renovations and
improvements failed to meet the second prong of the test because the life of
the improvements exceeded the term of the lease which was only five (5) years.

Determining the life of the real property improvements for the second prong of
the test is a fact issue, and the Comptroller’s office has not developed a
standard for when the test is met. ***** references Appendix A, titled
“Class Codes”, of the State Property Accounting Process User’s Guide for
depreciation of state capital assets that sets 264 months (22 years) as the
useful life for buildings and building improvements. [ENDNOTE 2]

The Campus’s expected useful life of 22 years is less than the 30 year (360
month) term of the Lease. Therefore, the 30 year term of the Lease is
sufficiently long to ensure that ***** will have the primary use and
benefit of the improvements under the Lease. The second prong of the test is
met, and the Lease is exempt under Texas Tax Code Section 151.311.

This ruling does not address the validity of any refund claim that might be
submitted by **. * may request a refund of Texas Sales and
Use Tax paid on taxable items purchased for construction of the Campus.
**** must obtain a properly completed assignment of right to refund for
items on which it did not directly pay the Texas Sales and Use Tax that are
part of any refund request. Any refund request is subject to the requirements
of Rule 3.325 (Refunds and Payments Under Protest).

If you have questions about this private letter ruling, please email us at the
following link, https://www.window.state.tx.us/taxhelp/ and please be sure to
reference Private Letter Ruling #150970893.

Sincerely,

Tax Policy Division

ENDNOTES:

1. The Association of Corporate Counsel defines a build-to-suit (or design-build)
   lease to be “essentially a landlord/developer’s agreement to construct a purpose
   built building, usually for a single tenant. The landlord will typically own or ground
   lease the lands (and once constructed, the building) and has the option of re-letting
   the building to a new tenant upon the expiry of the term of the build-to-suit lease
   to the original tenant. Build-to-suit leases typically are for a longer term than a
   normal lease in order to permit the landlord to recoup its investment over the
   duration of the lease term.”

2. In its request for a Private Letter Ruling, ** does not request a
   determination for the “building shell”. The guidance provided in this response
   does not approve or disapprove of **’s depreciation methodology or its
   choice of applicable class codes or descriptions.