Do a private developer's construction and design/build contracts to build a municipal hotel and convention center for a city's development district qualify as tax-exempt construction contracts?

Plain-English summary

The Texas Comptroller ruled that a private developer's contracts to design and build a municipal hotel and convention center for a city-created development district qualify as tax-exempt "exempt contracts" under Texas's contractor rules.

A city owned roughly 7.7 acres of land and leased it to a Municipal Development District (MDD) — a special district the city created under Local Government Code Chapter 377. The MDD then hired a private developer (through a development management agreement) and a design/builder (through a design/build agreement) to construct a hotel, convention center, parking, and infrastructure on the land. Once built, the hotel and convention center would be owned under a condominium arrangement: the MDD would own the hotel, and the convention center would go to the city, which would lease it back to the MDD; a hotel management company would then run day-to-day operations.

Texas's "exempt contract" rule covers construction contracts with entities that qualify for the governmental or religious/educational/public-service organization exemption. The key legal fact here: a municipal development district created under Chapter 377 is, by statute, a political subdivision of both the state and the city that created it — exactly the kind of governmental entity § 151.309(a)(5) exempts. Because the MDD itself qualified as an exempt entity, its construction contracts with the developer and design/builder qualified as exempt contracts, meaning materials incorporated into the project can be purchased tax-free by the contractors under the exempt-contract rules.

What this means for you

Cities and development districts pursuing hotel/convention-center or similar public projects

If your project is structured through a special-purpose district created under a Local Government Code chapter that designates the district as a political subdivision (like Chapter 377 municipal development districts), your construction contracts likely qualify as tax-exempt contracts, even though the actual builder is a private, for-profit company.

Private developers and design/build contractors working with government-created districts

Confirm your contracting counterparty's exact legal status. If it's a properly formed political subdivision (special district, development corporation, etc.) rather than simply a project partnership involving a government entity, your construction contract can qualify as exempt, letting you buy incorporated materials tax-free.

Accountants and tax professionals structuring public-private development deals

This ruling applies the same "exempt contract" doctrine (34 Tex. Admin. Code § 3.291(a)(5)) seen in other public-project rulings — the entity contracting for construction must itself be a governmental or § 151.310 exempt organization; the ultimate use of the finished building (leased back, operated by a private hotel brand, etc.) doesn't change that as long as the contracting entity's exempt status is established.

Common questions

Q: Does a special district created by a city automatically qualify for the governmental tax exemption?
A: Only if the enabling statute designates it as a political subdivision, as Local Government Code § 377.022(a) does for municipal development districts. Check the specific enabling law for each type of special district.

Q: Does it matter that a private company will manage the hotel after it's built?
A: Not for the exempt-contract determination on the construction phase — this ruling focused on whether the entity CONTRACTING for construction (the MDD) qualified as exempt, not on who eventually operates the finished building.

Q: Can a private, for-profit contractor buy materials tax-free under an exempt contract?
A: Yes, when the contract is with a qualifying exempt entity (governmental or religious/educational/public-service organization) for improvement of real property, materials incorporated into the project can be purchased tax-free under the exempt-contract rules.

Q: Can I rely on this ruling for my own development district or construction project?
A: Only if you're the taxpayer it was issued to. It binds the Comptroller solely as to that taxpayer's specific facts and can't be relied on by others, though it illustrates how the exempt-contract rule applies to municipal development districts specifically.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.309(a)(5) (Governmental Entities — exemption for counties, cities, special districts, political subdivisions)
• Tex. Tax Code § 151.310 (Religious, Educational, and Public Service Organizations)
• 34 Tex. Admin. Code § 3.291(a)(5) (Contractors — exempt contract definition)
• Tex. Loc. Gov't Code § 377.022(a) (Political Subdivision; Open Meetings)
• Tex. Loc. Gov't Code Chapter 377 (Municipal Development Districts)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/202108021L

Original ruling text

August 3, 2021

RE: Private Letter Ruling No. 20200131100904

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 Oct. 28, 2019, and supplemental correspondence on Dec. 15, 2019, Jan. 14, 2020, June 10, 2020, March 25, 2021, and April 15, 2021. Detrimental reliance relief is provided in accordance with Rule 3.10, Taxpayer Bill of Rights.

You requested guidance on whether contracts for the design and construction of the proposed municipal hotel and convention center project qualify as exempt contracts.

Facts Presented

The city of **, Texas (City) owns approximately 7.745 acres of real property (Property). City will lease the Property to ** Municipal Development District (MDD), a district that City created under Texas Local Government Code Chapter 377 (Municipal Development Districts).

MDD will enter into a development management agreement with COMPANY A (Developer) and a design/build agreement with COMPANY B (Design/Builder) to construct a qualified hotel (Hotel), qualified convention center facilities (Convention Center), surface parking, and infrastructure improvements on the Property (collectively, the Project).

Upon completion of the Project, the Hotel and Convention Center will be owned pursuant to a condominium declaration. MDD will own the Hotel and will convey the Convention Center to City, which City will lease to MDD. MDD will enter into a hotel services agreement with a nationally recognized hotel brand to manage the day-to-day operations of the Hotel and Convention Center.

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question: Will MDD’s development management agreement with Developer and design/build agreement with Design/Builder to construct the Project qualify as exempt contracts?

Ruling: Yes, MDD’s development management agreement with Developer and design/build agreement with Design/Builder to construct the Project will qualify as exempt contracts.

Analysis: Rule 3.291(a)(5) (Contractors) defines an “exempt contract” in relevant part as a contract for the improvement of real property with an entity that is exempted under Section 151.309 (Governmental Entities) or Section 151.310 (Religious, Educational, and Public Service Organizations). Section 151.309(a)(5) provides an exemption from sales or use tax for a taxable item sold, leased, or rented to, or stored, used, or consumed by a county, city, special district, or other political subdivision of this state.

MDD, the entity that will enter into the development management agreement with Developer and design/build agreement with Design/Builder, is a municipal development district formed under Texas Local Government Code Chapter 377. Texas Local Government Code Section 377.022(a) (Political Subdivision; Open Meetings) provides that a municipal development district is a political subdivision of this state and of the municipality that created the district.

Because a municipal development district is a political subdivision of this state, MDD qualifies for exemption from sales or use tax under Section 151.309(a)(5). Therefore, MDD’s development management agreement with Developer and design/build agreement with Design/Builder to construct the Project will qualify as exempt contracts.

The Texas Tax Code and Texas Administrative Code 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. 20200131100904.

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.