Do six separate 25-year build-to-suit leases with six different landlords, financing six new charter-school campuses at once, all qualify as exempt improvement-to-realty contracts?

Plain-English summary

The Texas Comptroller ruled that all six separate 25-year build-to-suit leases a charter school signed with six different landlords — financing six new campuses across multiple counties simultaneously — all qualify as exempt improvement-to-realty contracts under Section 151.311, letting every one of the six landlords buy construction materials and qualifying services tax-free.

This ruling batch-processed a school's expansion across six campuses at once, each structured the same way: a landlord acquires a site, builds new facilities to the school's specifications, and leases the finished campus back to the school for a 25-year primary term, with the school holding a purchase option. Applying the now-familiar two-prong test from Comptroller's Decision No. 28,391 (1993) uniformly across all six leases: the school easily met prong one as a qualified 501(c)(3) educational tax-exempt entity for every campus. On prong two, each campus's 25-year lease term exceeded the Comptroller's 22-year useful-life benchmark for buildings, with no early-termination provisions undercutting any of the six terms — so every lease passed, and the Comptroller issued one uniform ruling covering the school's building program across six different landlord relationships at once.

What this means for you

Charter school networks and multi-campus nonprofit expansions

If you're financing multiple campuses simultaneously through separate landlords using a consistent lease structure (same term length, same purchase option, no early-termination provisions), you can seek one combined private letter ruling covering the whole expansion rather than filing separately for each campus — as this school did across six simultaneous projects.

Developers financing multiple exempt-organization campuses at once

A consistent, sufficiently-long (relative to useful life) lease structure with no early-termination rights is the reliable pattern for Section 151.311 exemption across a portfolio of projects, as confirmed here across six separate landlord relationships all reaching the same result.

Accountants and tax professionals

Compare this ruling against the full set of companion charter-school lease rulings in this corpus: several 25-28 year GUARANTEED terms passed the two-prong test (including this six-campus batch), while shorter guaranteed terms (10 years, 20-year termination options within 25-year terms) failed — the consistent factor is whether the GUARANTEED term, without early-exit rights, meets or exceeds the Comptroller's useful-life benchmark.

Common questions

Q: Can one private letter ruling cover multiple separate leases with different landlords?
A: Yes, as this ruling shows — when the same tenant structures a consistent expansion (same lease terms, same exempt purpose) across multiple properties and landlords, the Comptroller can address them together in one ruling.

Q: Does having six different landlords instead of one change the exempt-contract analysis?
A: No — each lease is analyzed independently under the same two-prong test; having multiple landlords doesn't change the substantive requirements for any individual lease to qualify.

Q: Can another charter school network with a similar multi-campus expansion rely on this ruling?
A: No. It's binding on the Comptroller only for the requesting taxpayer and facts presented, and cannot be relied on by any other taxpayer — each of your own leases needs independent review against the two-prong test.

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 § 3.291(a)(5) (Contractors — exempt contract definition)
• 34 Tex. Admin. Code § 3.322 (Exempt Organizations)
• 34 Tex. Admin. Code § 3.1(d)(1) (prospective reliance); § 3.325 (Refunds and Payments Under Protest)
• Tex. Educ. Code §§ 12.105, 12.106, 12.128 (charter schools as public property held in trust)
• Comptroller's Decision No. 28,391 (1993) (originating two-prong test)
• Comptroller's Decision No. 31,505 (1994) (five-year lease failed second prong)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201709002L

Original ruling text

September 8, 2017

RE: Private Letter Ruling No. 2017010167

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE 1] We are responding to your request dated June 14, 2017. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on the exemption in Section 151.311 (Taxable Items Incorporated Into or Used for Improvement of Realty of an Exempt Entity) for tangible personal property and taxable services purchased for use in the performance of a contract to improve realty for an organization exempt under Section 151.310 (Religious, Educational, and Public Service Organizations).

Facts Presented

With its request for a private letter ruling, ** (Taxpayer) provided six Build to Suit Lease and Options (Leases). Taxpayer did not provide its federal exemption letter or documentation regarding its charter; however, Taxpayer provided this documentation with previously submitted private letter ruling requests. The following facts are based on information contained within the documentation provided by Taxpayer. Our response is based on these facts as presented, without independent verification or approval of the Taxpayer’s application of the State Property Accounting Process User’s Guide.

Taxpayer 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. As of August 19, 2013, Taxpayer met the qualifications for exemption from Texas Sales or Use Tax as outlined in Rule 3.322, Exempt Organizations. Taxpayer holds a charter from the Texas Education Agency (TEA) to operate an open-enrollment charter school. The TEA authorized Taxpayer to add six additional campuses (Campuses).

Taxpayer entered into Leases with the following landlords: (1) COMPANY A, for a ** County campus; (2) COMPANY B, for a * County campus; (3) COMPANY C, for a second County campus; (4) COMPANY D, for a County campus; (5) COMPANY E, for a County campus; and (6) COMPANY G, for a third *** County campus.

Under each of the six Leases, the Landlord agrees to acquire a site for the Campus, construct new facilities on the Campus per Taxpayer’s specifications, and lease the Campus to Taxpayer for a primary term of 25 years. Under each Lease, Taxpayer has the option to purchase the campus under specified terms and conditions.

The site of each new campus requires the construction of new facilities on real property. The Leases require Landlords to implement the construction projects and make all of the improvements to the Campuses. The costs of the improvements are incorporated into the Leases and paid for by Taxpayer in monthly installments using funds received from the State of Texas (State). All construction plans are subject to Taxpayer’s approval, and Landlords shall adopt any changes to the plans requested by Taxpayer unless the changes would not comply with applicable governmental rules and regulations.

The Campuses are leased by and used exclusively by Taxpayer as open-enrollment charter schools. Texas Education Code Section 12.105 states that an open-enrollment charter school is a part of the Texas public school system.

Taxpayer receives its funding from the State through a funding system known as the Foundation School Program as authorized by Texas Education Code Section 12.106. Taxpayer uses state funds to lease the Campuses. 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. The property may be used only for a purpose for which a school district may use school district property.

Taxpayer holds the deemed state-owned property in trust for the benefit of the attending students. If Taxpayer 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).

Taxpayer 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. This response relies upon the Taxpayer’s assertion that the useful life of the facilities is 22 years.

Questions, Rulings, and Analysis

Our restatement of your questions, our responses, and our analysis follow.

Question One: Are the Leases between Taxpayer and Landlords exempt contracts under Section 151.311?

Ruling: The Leases are exempt contracts under Section 151.311 because they are contracts to improve realty for the primary use and benefit of an exempt entity.

Analysis:

In relevant part, Section 151.311 addresses contracts for an improvement to realty for an organization exempted from sales and use tax under Section 151.310. Section 151.311 does not require that the exempt organization own the real property improvements. The Section may apply where the exempt organization leases the real property.

An “exempt contract” includes a contract with a non-exempt entity to improve real property for the primary use and benefit of an organization exempted under Section 151.310. Rule 3.291(a)(5) (Contractors). The Comptroller 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 (1993).

First, the lessee must qualify for exempt status. Based on the facts presented, Taxpayer 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. The Comptroller has consistently applied this test. See for example, Comptroller’s Decision No. 31,505 (1994), 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 years.

Determining the life of the real property improvements for the second prong of the test is a fact issue, and the Comptroller has not developed a standard for when the test is met.

The Campuses’ expected useful life of 22 years is less than the 25-year (300 month) term found in the Leases. Therefore, the 25-year term of the Leases is sufficiently long to ensure that Taxpayer has the primary use and benefit of the improvements under the Leases. The second part of the test is met, and the Leases are exempt under Section 151.311.

Question Two: Can Landlords issue exemption certificates in lieu of paying tax on purchases of taxable items for use in performance of the exempt contracts with Taxpayer?

Ruling: Landlords may issue exemption certificates in lieu of paying tax on purchases of tangible personal property that is incorporated into the realty in the performance of the exempt contracts; tangible personal property, other than machinery and equipment, that is necessary and essential for the performance of the exempt contracts and is completely consumed at the job site; and taxable services that meet the requirements in Section 151.311(c).

Analysis:

Section 151.311 creates an exemption from sales tax on the purchase of tangible personal property that is incorporated into the realty in the performance of an exempt contract. Section 151.311(a).

Section 151.311 also exempts the purchase of tangible personal property, other than machinery or equipment and its accessories and repair and replacement parts, in the following circumstances: (1) the tangible personal property is necessary and essential for the performance of the exempt contract; and (2) the tangible personal property is completely consumed at the job site. Section 151.311(b).

The statute further provides that the purchase of a taxable service for use in the performance of an exempt contract is exempt if the service is performed at the job site and either (1) the contract expressly requires the specific service to be provided or purchased by the person performing the contract, or (2) the service is integral to the performance of the contract. Section 151.311(c).

Under Rule 3.1(d)(1), these rulings may be relied on prospectively from the date of this response and do not address the validity of any refund claim that might be submitted by Taxpayer. Any refund request is subject to the requirements of Rule 3.325, Refunds and Payments Under Protest.

Comptroller’s Decisions and STAR documents cited are on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 2017010167.

Sincerely,

Tax Policy Division – Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code