Could a private lessor buy materials and services tax-free for GSA-required improvements to its leased building?

Plain-English summary

A private building owner agreed to make extensive GSA-designed improvements as a condition of a 15-year federal lease. The attached correspondence shows the Comptroller first denied the exemption in July, reconsidered that answer in August, and issued a final certificate clarification in November.

The reconsidered ruling treated GSA as the primary user and beneficiary. GSA designed the costly improvements, required satisfactory completion, would use them exclusively during the lease, and the lessor apparently would have no use for them after the lease. Receiving rent did not by itself make the lessor the primary beneficiary.

The November clarification allowed the lessor to issue an exemption certificate for goods and services incorporated into the realty for GSA's primary use and benefit. A resale certificate was appropriate only when the lessor separately resold the supplier's goods or services to GSA. Property leased with real estate did not qualify as a sale for resale merely because it accompanied the lease.

The work-specific rules in the reconsideration allowed incorporated materials for qualifying new construction or remodeling to be purchased under the applicable exemption or resale treatment. Property used but not incorporated remained taxable. Security services sold directly to GSA or incorporated for GSA could be purchased for resale, while job-site guards hired for the contractor's own use were taxable. Furniture and other tangible property merely included with the building lease remained taxable to the lessor.

What this means for you

Government occupancy alone did not decide the issue. The ruling relied on documented primary use and benefit, the nature of each construction or service transaction, whether property was incorporated into the realty, and whether anything was separately resold to GSA.

Common questions

Did private ownership of the building prevent the exemption? No, after reconsideration, because the facts showed GSA was the primary user and beneficiary of the improvements.

Could the lessor give every supplier a resale certificate? No. Resale treatment required a separate resale of that supplier's goods or services to GSA.

What certificate applied to incorporated improvements for GSA? The final letter allowed an exemption certificate.

Were tools or other property used but not incorporated exempt? No.

Was furniture simply leased with the building exempt? No. The letter treated that tangible property as taxable to the lessor unless another stated exemption applied.

Citations and references

• Tex. Tax Code § 151.006(2) (sale-for-resale exclusion for property rented incidentally with real estate)
• 34 Tex. Admin. Code Rule 3.291(c)(4)(A)-(B) (new construction for exempt entities)
• 34 Tex. Admin. Code Rule 3.357(b)(5)(A) and (d)(1) (nonresidential real-property remodeling)
• 34 Tex. Admin. Code Rule 3.333 (security services)
• 34 Tex. Admin. Code Rule 3.294(j) (tangible property included with a real-property lease)
• 34 Tex. Admin. Code Rule 3.322(f)(3) (government purchase vouchers)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9011L1058A12

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TX 78774

BOB BULLOCK
Comptroller November 9, 1990

Dear *:

I would like to follow up my letter of August 24, 1990 (a copy of which
is attached) regarding tax exemption for improvements to realty leased
to the GSA (General Services Administration), in order to clarify the
difference between and the correct usage of resale and exemption certi-
ficates in such situations.

First, a resale certificate may be issued in lieu of tax only when a
transaction is a "sale for resale" as defined in the Texas Tax Code. The
definition specifically excludes sales of tangible personal property to
one who will lease or rent the tangible personal property to another per-
son "if incidental to the leasing or renting of real estate." Section
151.006 (2). This applies to part of the transaction you described.

Therefore, it is inappropriate for the lessor of the realty in question
to issue a resale certificate to any materials supplier, service provid-
er or subcontractor unless the lessor will separately resell that per-
son's goods or services to the GSA.

However, an exemption certificate may be issued in lieu of tax when a
transaction is otherwise exempt from tax by Texas law.

Therefore, the lessor you represent may issue an exemption certificate
to purchase goods and services that will be incorporated into the leased
realty for the primary use and benefit of the GSA.

Which type of certificate a subcontractor or service provider may issue
or accept likewise depends on whether the transaction with his supplier
or the lessor is a "sale for resale," or is otherwise exempt.

I hope this clarifies the issue. If you have further questions, feel
free to write or call me at 1-800-531-5441, ext. 3-3889.

Sincerely,
John Christian
Taxability Section/Legal Services Division

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TEXAS 78774

BOB BULLOCK
Comptroller August 24, 1990

Dear *:

Thank you for your August 3, 1990 letter requesting reconsideration of
our determination that certain improvements to realty were not tax
exempt. Upon further review, it appears that much of the transaction
is exempt.

According to your facts, the General Services Administration (a tax-
exempt federal government agency) is leasing a building from a private
entity. The lease contract expressly requires the lessor to perform
substantial structural modifications. These include the building of a
second floor, an elevator, installation of security, sprinkler and smoke
detection devices, and the gutting and redesign of the interior.

Please refer to Jo Ann Dieck's letter of July 6, 1990, which explains
that the improvements consist of both new construction and remodeling
of nonresidential real property, as well as security services and per-
haps sale and installation of tangible personal property.

Current law permits tax exemption for improvements to realty made for
the primary use and benefit of a tax exempt entity. Applying this test
to your situation, it appears that the exempt entity (the GSA) will be
the primary beneficiary and user of the improvements to the property
it is leasing.

After all, the GSA designed the improvements (which are extensive and
costly, tailored them to its needs, conditioned acceptance of the lease
on their satisfactory completion, and will be their sole user during
the 15-year lease. After the lease expires the lessor will apparently
have no use for the improvements. In view of these facts, the receipt
of lease payments by the private lessor does not by itself constitute
"primary use and benefit. " Therefore, the rules allow the following
exemptions. The type of work being done determines which exemption, if
any, applies.

For new construction, the contractor may issue an exemption certificate
to purchase tangible personal property to be incorporated into the real
property being improved for the GSA. Rule 3.291 (c)(4)(A). He must pay
tax on tangible personal property used in the new construction but not
incorporated into the real property. Rule 3.291 (c)(4)(B).

For real property remodeling, he may issue a resale or exemption certi-
ficate to purchase tangible personal property to be incorporated into
the real property. Rule 3.357 (b)(5)(A). He must pay tax on tangible
personal property used in remodeling but not incorporated into the real
property. Rule 3.357 (d)(1).

In addition, he may issue a resale certificate for security services
sold directly to the GSA and/or incorporated into real property for the
GSA. He must pay tax on security services purchased for his own use
(i.e., hiring guards to protect the construction site). Rule 3.333.

The lessor must pay tax on tangible personal property (not otherwise ex-
empt as outlined above) that is included in the lease of real property.
Rule 3.294 (j). For example, he must pay tax on furniture leased togeth-
er with the building but neither sold to the GSA nor incorporated into
the real property.

As you mentioned in your letter, purchase vouchers issued by the GSA
will prove its exempt status. Rule 3.322 (f)(3).

This opinion is based on the facts presented. Different facts may re-
sult in different answers. If you have further questions, please feel
free to write or call me at 1-800531-5441, ext. 3-3889.

Sincerely,
John Christian
Taxability Section
Legal Services Division

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, TX 78774

BOB BULLOCK
Comptroller July 6, 1990

Dear *:

Thank you for your letter concerning sales and use tax applicable to
tangible personal property to be incorporated in real property which
is leased by the taxpayer to the General Services Administration
(GSA) agency of the U.S. Government. Following are the facts described
in your letter:

The taxpayer, the owner and lessor of a warehouse office showroom
containing approximately 32,000 rentable square feet, has entered in-
to an agreement to lease it to the GSA which is to be converted for
use as a military entrance processing station.

In the lease agreement, the GSA required that the taxpayer retrofit
the one-story warehouse building into a multi-office configuration
designed by the GSA to meet their requirements for processing mili-
tary personnel. As a condition of the 15-year lease agreement, the
contract requires significant structural changes to the interior of
the building including the conversion of 6500 square feet of space
into two floors and the installation of an elevator. Among other GSA
structural modification requirements are that the interior of the
building be gutted and redesigned to meet the governmental and mili-
tary code acoustical specifications. Personal property such as fire
prevention, safety, sprinkler and smoke detection controls, security
system, certain fixtures, mailboxes, lockers, a public address system,
etc., will also be purchased.

Although the GSA did not actually purchase the materials, supplies
or other personal property, the requirements for modifications were
incorporated into the lease agreement between the taxpayer and the
GSA.

You stated that the GSA will make monthly lease payments to the tax-
payer. The lease payment is not bifurcated into the amount due for
rental of the land and building and the amount due for the tangible
personal property being incorporated into the building.

The tangible personal property purchased by the taxpayer and incorpo-
rated into the real property does not qualify for sales tax exemption.
The property being improved belongs to the taxpayer with primary bene-
fit for the taxpayer being the lease of the property. Although a gov-
ernmental agency will lease the improved property, the government is
not leasing tangible personal property for which a tax exemption could
be claimed.

Based on the facts of your letter, both new construction and remodeling
are being performed. The addition of the second floor within the exist-
ing structure which does not require raising the roof is new construc-
tion. The finish out of the second floor would also be new construc-
tion. The addition of an elevator within an existing structure is re-
modeling. The elevator would be considered new Construction only if it
were additional space added outside the existing structure.

The gutting and restructuring of the existing structure is remodeling.
The addition of fire prevention, safety, sprinkler and smoke detection
controls would be considered remodeling if these items are incorporated
into the structure in such a manner as to constitute an improvement to
realty. This would also be true of the fixtures, mailboxes, lockers,
and public address system. However, additional information describing
the manner of installation is needed before a specific determination can
be made if these items are improvements to realty or remain tangible per-
sonal property.

The installation of a security system is a security service subject to
tax as outlined in the enclosed Rule 3.333.

Tangible personal property included in the lease of the real property is
taxable to the taxpayer.

If the taxpayer (real property owner) contracts or subcontracts the real
property improvements to a third-party, the taxpayer will owe tax to
the contractor on the materials incorporated into the property under a
separated contract for new construction. Under a lump-sum contract, the
contractor owes tax on the materials at the time of purchase and cannot
claim a tax exemption because the real property lessee is a governmental
entity. The charge to the taxpayer for the lump-sum contract is not tax-
able.

The total charge for remodeling the real property is taxable to the tax-
payer. The person performing the remodeling can purchase the materials
incorporated into the property tax free under a resale certificate.

The total charge for items that remain tangible personal property is
taxable. This includes any transportation or delivery charges and in-
stallation labor.

Tangible personal property that the taxpayer purchases for sale (trans-
fers title and possession for consideration) to the governmental entity
for the entity's own use qualifies for exemption from sales tax. The
taxpayer can purchase those items tax free under a resale certificate.
If the taxpayer provides a security service, or performs remodeling ser-
vices for the governmental entity, the charges to the governmental enti-
ty for the services are exempt from tax.

This opinion is based on the facts presented. If there are additional
or different facts, the opinion may change.

If you have any questions or need additional information, you may call
toll free 1-800-252-5555, or the regular number 512/4634600. My exten-
sion is 3-4666. You may write to Tax Correspondence; Comptroller of
Public Accounts.

Sincerely,
Jo Ann Dieck
Tax Correspondence