Does the same 25-year build-to-suit exempt-contract analysis apply when a Texas charter school's new campus houses two combined school campuses under one lease, rather than a single campus?

Plain-English summary

This ruling was issued the same day as a nearly identical companion ruling to the same charter school operator, and reaches the same result on a closely related fact pattern: instead of a single high school campus, this ruling addresses a build-to-suit lease for a facility housing two combined school campuses at one site. The Texas 501(c)(3) nonprofit charter holder (funded through the state's Foundation School Program, with charter-held property treated as state property in trust under Texas Education Code Section 12.128) entered into a build-to-suit lease and purchase option with a non-exempt landlord, who agreed to construct the combined-campus facility to the school's specifications and lease it back for an initial 25-year term (with an earlier-starting, longer-running purchase option than the companion single-campus deal).

Applying the identical two-prong test from Comptroller's Decision No. 28,391 (1993), the Comptroller ruled the lease qualifies as an exempt contract under Tax Code Section 151.311: (1) the charter school satisfies Section 151.310's exempt-entity requirement, and (2) the 25-year (300-month) lease term exceeds the Campus's referenced 22-year (264-month) useful life (per the state's own depreciation schedule), giving the school the primary use and benefit of the improvements. As a result, the landlord's contractors could purchase construction materials and services for the combined-campus project tax-free.

As with the companion single-campus ruling, the Comptroller left open (without approving or disapproving) any separate refund claim the school might pursue for materials on which tax was already paid, and didn't address the "building shell" specifically, since that wasn't part of the request. The Comptroller again noted this fact pattern (exempt lessee, non-exempt lessor, pre-occupancy improvements) will be folded into a future Rule 3.291 amendment, building on four 2014 rulings addressing similar facts.

What this means for you

Charter schools consolidating or co-locating multiple campuses

Combining two campuses into a single build-to-suit facility doesn't change the exempt-contract analysis — the same two-prong test (exempt lessee status, plus a lease term at least as long as the improvements' useful life) applies regardless of whether the facility serves one campus or multiple combined campuses.

Real estate developers building combined/multi-campus facilities for exempt tenants

The same 22-year useful-life benchmark and 25-year-or-longer lease-term structuring guidance applies here as in single-campus deals — there's no separate or more demanding standard for combined-campus projects.

Accountants and tax professionals

This pair of same-day rulings (one per campus configuration) illustrates that the Comptroller applies its two-prong exempt-contract test consistently regardless of facility complexity — the analysis turns on lessee exempt status and the lease-term-to-useful-life comparison, not on how many campuses or programs are housed in the leased facility.

Common questions

Q: Does combining two campuses into one leased facility change the exempt-contract analysis?
A: No. The Comptroller applied the identical two-prong test and reached the same result as it did for a single-campus version of this transaction issued the same day.

Q: What is the useful-life benchmark used here?
A: 22 years (264 months), drawn from the state's official depreciation schedule (Appendix A of the State Property Accounting Process User's Guide) for buildings and building improvements — the same figure used in the companion single-campus ruling.

Q: Does this ruling authorize a tax refund for materials already purchased?
A: No. The Comptroller explicitly declined to address the validity of any refund claim, which would be a separate process under Rule 3.325.

Q: Can another charter school or multi-campus operator rely on this ruling?
A: No. This is a private letter ruling binding only on the Comptroller as to this taxpayer and these facts, though the reasoning mirrors the companion single-campus ruling issued the same day and several other same-doctrine 2014 rulings.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.311 (exempt contracts for realty improvements)
• Tex. Tax Code §§ 151.309, 151.310 (governmental/exempt organization exemptions)
• 34 Tex. Admin. Code Rule 3.291(a)(5) (exempt contract definition)
• 34 Tex. Admin. Code Rule 3.322 (exempt organizations)
• 34 Tex. Admin. Code Rule 3.325 (refunds and payments under protest)
• Tex. Educ. Code §§ 12.105, 12.106, 12.128 (charter schools; Foundation School Program; charter-held property as state property)

Prior authority discussed:

• Comptroller's Decision No. 28,391 (July 7, 1993), STAR Document No. 9307H1248D05 (two-prong test established)
• Comptroller's Decision No. 31,505 (April 20, 1994), STAR Document No. 9404H1297E01 (5-year lease failed second prong)
• STAR Document Nos. 201411982L, 201411981L, 201411980L, 201409958L (2014 rulings on similar facts)

Related ruling discussed:

• Same-day companion ruling to the same charter school operator addressing an analogous single-campus build-to-suit lease (STAR 201509416L)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201509417L

Original ruling text

September 2, 2015

RE: Private Letter Ruling # 143430420

Dear *****:

We issue this private letter ruling in accordance with Rule 3.1 in response to
your request dated December 3, 2014. 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

**, 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. On August 19, 2013, ** 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. * recently has had a new facility
constructed at *, CITY, Texas for the *and *
campuses (“Campus). * entered into a build-to-suit lease [ENDNOTE 1]
and purchase option (“Lease”) with * (“Landlord”), where Landlord
agreed to construct the Campus per *’s specifications and to lease
the Campus to * for an initial term of twenty-five (25) years. Under
the Lease, ** has the option to purchase the Campus after the first
anniversary of the Commencement Date, as defined in the Lease, until the
termination of the Lease.

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 *either in monthly payments or by
exercising its option to purchase. The Lease requires Landlord to make all
improvements described within the exhibits to the Lease. The Campus was
improved for, leased by, and used 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 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.

Texas Tax Code Section 151.311 does not require that the real property be owned
by the exempt organization. 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’S 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 25 year (300
month) term of the Lease. Therefore, the 25 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 part 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
https://www.window.state.tx.us/taxhelp/ and reference Private Letter Ruling

143430420.

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.