Is a 25-year build-to-suit lease for a Texas charter school campus an exempt contract, letting the landlord/developer buy construction materials tax-free?

Plain-English summary

The Texas Comptroller ruled that a private landlord constructing a new charter-school campus under a 25-year build-to-suit lease can buy construction materials and services tax-free, applying the two-part test for whether a contract to improve real estate qualifies as an "exempt contract" under § 151.311. A Section 501(c)(3) nonprofit operating an open-enrollment charter school entered a 25-year lease with a private landlord, who agreed to acquire the site, build the campus to the school's specifications, and lease it back — with the school paying via monthly installments funded by state education dollars.

Texas law exempts materials/services bought for a construction contract that primarily benefits a tax-exempt organization — even when the exempt entity doesn't own the property, and even when the actual contracting party (here, the landlord) isn't itself exempt. The test has two prongs: (1) the ultimate occupant/lessee must be a qualifying exempt entity — easily met here since the school is exempt under § 151.310; and (2) the LEASE TERM must be long enough, relative to the improvements' useful life, that the exempt lessee (not the landlord) gets the real economic benefit of the construction. The Comptroller applied its own 22-year useful-life benchmark for non-componentized buildings (from its internal Class Codes guide) as the yardstick — since the school's 25-year lease exceeds that 22-year figure, the second prong is satisfied and the whole lease qualifies as an exempt contract.

The ruling also leaned on Texas Education Code provisions establishing that state-funded charter school property is legally "public property," held in trust for students — reinforcing that the ultimate beneficiary here is genuinely a public education function, not a private commercial landlord.

What this means for you

Charter schools structuring build-to-suit facilities

If your school is financing a new campus through a long-term lease with a private developer/landlord rather than direct ownership, the landlord can potentially buy construction materials and services tax-free — but the lease term needs to be long enough relative to the building's expected useful life. The 22-year useful-life benchmark for non-componentized buildings (drawn from the Comptroller's own Class Codes guide) is a concrete number to design your lease term around; a lease shorter than the useful life of the improvements risks failing the second prong (as happened in a 1994 case with a 5-year lease and long-lived renovations).

Real estate developers and landlords building for exempt tenants

You don't need to be tax-exempt yourself to buy construction materials tax-free under § 151.311 — what matters is whether your lessee is exempt AND whether your lease term is long enough that the exempt lessee, not you, gets the primary use and benefit of what you're building.

Construction contractors on exempt-entity projects

Confirm the lease term/useful-life analysis has actually been done (and ideally documented in a PLR like this one) before accepting exemption certificates from a landlord on a charter-school or similar project — the exemption depends on facts specific to each lease, not just the tenant's tax status.

Common questions

Q: Does the charter school need to own the building to get this exemption?
A: No — § 151.311 doesn't require the exempt organization to own the property. A long-enough lease is sufficient, as this ruling confirms.

Q: What makes a lease term "long enough"?
A: The Comptroller compares the lease term to the expected useful life of the improvements. Here it used its own 22-year useful-life figure for non-componentized buildings; a 25-year lease term cleared that bar. There's no fixed statutory number — it's a fact-specific comparison, but this ruling supplies a concrete reference point.

Q: What happens if the lease term is too short relative to the building's useful life?
A: The exempt contract test fails on the second prong — as the Comptroller found in a 1994 decision involving a 5-year lease for improvements with a much longer useful life.

Q: Can another charter school rely on this ruling?
A: No. It binds the Comptroller only as to the taxpayer and facts in this specific request and cannot be relied on by any other taxpayer, though the 22-year benchmark and two-prong framework are reusable reference points.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.311 (exempt contract — improvement of realty of an exempt entity)
• Tex. Tax Code § 151.310 (religious, educational, and public service organizations)
• Tex. Educ. Code § 12.105, § 12.106, § 12.128 (charter school public-property status)
• 34 Tex. Admin. Code Rule 3.322 (Exempt Organizations)
• 34 Tex. Admin. Code Rule 3.291(a)(5) (exempt contract definition)
• 34 Tex. Admin. Code Rule 3.1(d)(1); Rule 3.325
• Comptroller's Decision No. 28,391 (1993); No. 31,505 (1994)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201901040L

Original ruling text

January 15, 2019

RE: Private Letter Ruling No. 20180802151052

** d/b/a COMPANY A, Taxpayer No. **

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters.[1] We are responding to your request dated July 31, 2018 and e-mails dated Aug. 14, 2018, Aug. 28, 2018, and Sept. 11, 2018. 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

** d/b/a COMPANY A (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 on Sept. 5, 2003. As of Sept. 6, 2002, Taxpayer met the qualifications for exemption from Texas Sales or Use Tax outlined in Rule 3.322 (Exempt Organizations).

Taxpayer provided its federal exemption letter, documentation regarding its charter, and a Build to Suit Lease and Option (Lease). The facts are based on information contained within the documentation provided by Taxpayer. Our response is based on these facts as presented.

On April 24, 2008, Taxpayer entered into a charter contract with the Texas Education Agency (TEA) to operate an open-enrollment charter school through July 31, 2013. The charter contract was renewed on June 7, 2013 through July 31, 2023. The TEA authorized Taxpayer’s campus located at ADDRESS, CITY, TX * (Campus). The Campus will include an elementary and a middle school.

On June 4, 2018, Taxpayer entered into the Lease with COMPANY B, (Landlord) to finance the construction of the Campus. Under the Lease, Landlord agreed 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 term beginning on the Commencement Date, as defined in the Lease, and continuing for a period of 25 years after the Rent Commencement Date, which is defined in the Lease as the Substantial Completion Date. Per Taxpayer’s July 31, 2018 submission, Substantial Completion had not occurred. Under the Lease, Taxpayer has the option to purchase the Campus during the period described in the Lease.

The site of the new campus requires the construction of new facilities on previously unimproved real property. The Lease requires Landlord to implement the construction projects and make all of the improvements to the Campus described within Exhibit C to the Lease. The costs of the improvements are incorporated into the Lease 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 Landlord shall adopt any changes to the plans requested by Taxpayer unless the changes would not comply with applicable governmental rules and regulations.

The Campus is leased by and used exclusively by Taxpayer as an open-enrollment charter school. Texas Education Code Section 12.105 (Status) states that an open- enrollment charter school is 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 (State Funding). Taxpayer uses state funds to lease the Campus. Texas Education Code Section 12.128 (Property Purchased or Leased with State Funds) states that property, whether purchased or leased, is considered public property for all purposes allowed by state law and is deemed 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).

Questions, Rulings, and Analysis

Our restatement of your questions is shown below, followed by our responses and analysis.

Question One: Is the Lease between Taxpayer and Landlord an exempt contract under Section 151.311?

Ruling One: The Lease is an exempt contract under Section 151.311 because it is a contract to improve realty for the primary use and benefit of an exempt entity.

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

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

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. See 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, Taxpayer 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.

Taxpayer did not state the Campus’s expected useful life. The Comptroller’s State Property Accounting Process User’s Guide – Appendix A – Class Codes (Class Codes) provides guidance when calculating the expected useful life for building improvements. According to the Class Codes, the useful life for buildings and building improvements – non-componentized is 264 months (22 years).

Using the Class Codes guideline, the Campus’s expected useful life of 22 years is less than the 25-year term found in the Lease. Therefore, the 25-year term of the Lease is sufficiently long to ensure that Taxpayer has 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 Section 151.311.

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 contracts. 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 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. 20180802151052.

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.