Is converting a plugged oil or gas well into a water well taxable as remodeling under Texas sales tax rules, and how does sales tax apply to water well drilling, equipment, and repairs?

Plain-English summary

This 1993 Comptroller letter answers a water-well driller/servicer's questions about how Texas sales and use tax applies across the life cycle of a water well: drilling, equipment installation, repair, and remodeling.

The headline answer, buried near the end, is the taxpayer's specific question: converting a plugged oil or gas well into a water well counts as "remodeling." So does plugging an existing water well, even when required under Texas Water Commission rules. By contrast, cleaning out an existing water well is a "repair," not remodeling. The distinction matters because whether repair/remodeling labor on a well is taxable turns on whether the well is used for residential or nonresidential purposes at the time the work is performed — nonresidential repair/remodeling labor became taxable January 1, 1988 (Rule 3.357), while labor to repair a well supplying only a residence is not taxable. Deepening an existing well by drilling further down is treated as new construction, not remodeling, because it adds new footage.

The letter also lays out the broader tax mechanics: drilling and casing a well is an improvement to real property, but the equipment inside the well (pumps, tubing, sucker rods, pipe) is tangible personal property. Under a lump-sum contract, the driller is the consumer and owes tax on materials/equipment; under a separated contract, the driller can buy materials tax-free with a resale certificate and must collect tax from the customer on the materials (labor to drill/case is not taxable). Special rules apply for exempt entities (public school districts; nonprofit charitable hospitals under Health and Safety Code Chapters 241 or 577) and for farm/ranch wells used exclusively in agricultural operations.

What this means for you

Water well drillers and pump installers

Track whether each well you work on is residential or nonresistential (including mixed agricultural use) at the time of the job, because that classification — not the type of work alone — drives whether repair and remodeling labor is taxable. Converting an old oil/gas well to a water well, or plugging a water well, is remodeling; simply cleaning out a well is a repair. If you both deepen (new construction) and remodel a well in the same contract, see Rule 3.357(b)(7) and (c)(3) for how to apportion the contract.

Oil and gas operators considering well conversion

If you convert a plugged oil or gas well into a water well, expect that conversion labor to be treated as taxable remodeling of real property when the resulting well serves nonresidential use (including agriculture), and non-taxable only if the well exclusively supplies a residence.

Farmers, ranchers, schools, and nonprofit hospitals

Wells drilled for exclusive use in agricultural operations (watering livestock, irrigating crops for sale) can qualify for exemption certificates on in-well equipment (though casing itself remains taxable as a realty improvement under a separated contract). Public school districts and certain Chapter 241/577 nonprofit hospitals can also furnish exemption certificates so contractors buy materials tax-free.

Common questions

Q: Is converting a plugged oil well into a water well taxable?
A: The conversion itself is classified as "remodeling." Whether the remodeling labor is taxable depends on whether the resulting water well serves residential use only (not taxable) or nonresidential/mixed use such as agriculture (taxable, effective January 1, 1988 under Rule 3.357).

Q: Is plugging an existing water well taxable?
A: Plugging a water well — even when done under Texas Water Commission rules — is also treated as remodeling, subject to the same residential/nonresidential taxability test.

Q: Is cleaning out a well the same as remodeling for tax purposes?
A: No. Cleaning out an existing water well is classified as a repair, not remodeling, though the same residential/nonresidential taxability test still applies to the labor.

Q: What about deepening an existing well?
A: Labor to deepen a well by drilling additional depth is new construction labor, not remodeling, because new footage is added to the well.

Q: How is tax handled differently for lump-sum vs. separated contracts to drill and equip a well?
A: Under a lump-sum contract, the driller is the consumer and pays tax on all materials/equipment at purchase, and the charge to the customer is not taxable. Under a separated contract, the driller can buy materials/equipment tax-free with a resale certificate but must collect tax from the customer on the materials; labor to drill and case the well is not taxable.

Q: Are there exemptions available?
A: Yes — public school districts, nonprofit charitable hospitals licensed under Health and Safety Code Chapter 241 or 577, and farm/ranch wells used exclusively for agricultural operations (watering livestock, irrigating crops for sale) can furnish exemption certificates in lieu of tax on qualifying materials, equipment, or labor, subject to the specific conditions described in the letter.

Citations and references

Rules cited:

• 34 Tex. Admin. Code Rule 3.291 (contractor tax responsibilities, including subsection (c) for exempt customers and the Rule 3.291(b)(2)(B) consumable-supplies exception in separated contracts)
• 34 Tex. Admin. Code Rule 3.357 (repair and remodeling of nonresidential real property, including subsections (b)(7) and (c)(3) for contracts mixing new construction and remodeling)
• Health and Safety Code Chapter 241 and Chapter 577 (nonprofit charitable hospital licensing referenced for the exemption-certificate provisions)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9301758L

Original ruling text

ALERT: This document may be affected by changes to the Tax Code which was amended by H.B. 268, 82nd Reg. Legislative Session, 2011. The amendment required persons claiming a sales tax exemption for certain agricultural and timber products to apply for and provide a registration number issued by the Comptroller, effective 01/01/2012.

January 8, 1993

Dear ****:

Thank you for your letter concerning water well construction, repair, and pump
sales.

Drilling and installing casing in water wells is considered to be improvements
to realty. However, the equipment (pumps, including submersible pumps, tubing,
sucker rods, pipes, etc.) within the well is tangible personal property.
Above-ground tanks and piping are tangible personal property. Tanks and piping
installed below the ground would be considered improvements to realty.

Under a lump-sum contract to drill and case a water well and install the
equipment, you are considered to be the consumer and must pay tax on all
materials/equipment at the time of purchase. The charge to your customer would
not be taxable. This applies to jobs for residential and nonresidential
customers, including farms and ranches. However, if your contract is with a
public school district or a nonprofit charitable hospital licensed under
Chapter 241 or 577 of the Health and Safety Code, you may purchase the
materials tax free under an exemption certificate. Section (c) of the enclosed
Rule 3.291 explains your tax responsibilities when improving real property for
those exempt customers. There is a prior contract exemption on contracts to
improve realty for other exempt entities you entered into a contract with
before August 15, 1991.

Under a separated contract to drill and case a water well and install the
equipment, you may purchase materials/equipment installed into the well tax
free by issuing a resale certificate to your supplier. You will collect tax
from your customer on the materials/equipment. The labor to drill the well and
install the casing is not taxable. This applies to residential and
nonresidential customers. If your contract is with an exempt organization, you
may accept a valid and complete exemption certificate from the organization in
lieu of collecting tax on the materials.

When a well is drilled on a farm or ranch for exclusive use in agriculture
operations (for watering livestock and irrigation of crops for sale in the
regular course of business), an exemption certificate can be accepted in lieu
of tax on the equipment installed inside the well under a separated contract.
Tax must be collected on the casing because it becomes an improvement to
realty. You may issue a properly completed resale certificate when purchasing
the equipment and casing.

If you do not drill the well, but only sell and install the equipment in a new
well, the total charge to the customer is taxable whether or not separately
stated. Installation labor became taxable October 1, 1987. You may purchase
the installed equipment tax free under a resale certificate. If you sell and
install equipment for an exempt organization, a valid and properly completed
exemption certificate can be accepted in lieu of tax on the equipment and
installation labor. If the farm or ranch well is exclusively used in
agriculture operations, a valid and properly completed exemption certificate
can be accepted in lieu of tax on the materials and installation labor.

The total charge for labor and materials to repair the equipment is taxable.
You may purchase materials that are transferred to the customer tax free under
a resale certificate whether you bill lump-sum or separated repair charges. If
your customer is an exempt organization or the well is on a farm or ranch and
exclusively used in agricultural operations, a valid and complete exemption
certificate can be accepted in lieu of tax on the materials and repair labor.

The labor to perform repairs on the well formation and casing is the repair of
improvements to real property and is not taxable if the well is used to supply
water to the residence. Your tax responsibilities would be the same as when
you are drilling a new well (lump-sum or separated contract - Rule 3.291).

Labor to repair or remodel nonresidential real property became taxable January
1, 1988. Please refer to the enclosed Rule 3.357. The labor to perform
repairs on the well formation and casing is taxable if the well is used to
supply water both for residential and nonresidential use (i.e., residence and
agriculture use) or only nonresidential use (i.e. agriculture use). If your
customer is an exempt organization, a valid and properly completed exemption
certificate can be accepted in lieu of collecting tax on the taxable service.

I hope this general explanation answers most of your questions. To answer your
more specific question, converting a plugged oil well into a water well is
remodeling. In addition, plugging an existing water well, even under the rules
of the Texas Water Commission, is remodeling. Cleaning out an existing water
well is a repair. The taxability of the repair or remodeling of improvements
to realty is based on whether the water well is residential or nonresidential
at the time the work is performed.

The labor to deepen an existing water well by digging deeper is considered new
construction labor because new additional footage is added to the well. See
sections (b)(7) and (c)(3) of Rule 3.357 if you do both new construction and
remodeling in the same contract.

You must collect tax from a water supply corporation if a valid and properly
completed exemption certificate is not issued at the time of sale. Nonprofit
water supply corporations generally are not exempt organizations.

A taxable repair does not have to be successful in order to be subject to sales
and use tax. However, if you refund a portion of the selling price of the
taxable repair service to the customer, you may also refund the tax on the
refunded amount.

Unless you are improving the realty of a public school district or a nonprofit
charitable hospital licensed under Chapter 241 or 571 of the Health and Safety
Code, equipment and consumable supplies that you purchase, lease, or rent in
order to perform the work are taxable to you. You are the consumer of the
equipment and consumable supplies even if the cost is separately stated to your
customer.

There is an exception in Rule 3.291(b)(2)(B) for consumable supplies (but not
equipment) sold in separated contracts to improve realty. The exception must
be strictly followed in order for you to be a seller of the consumable supplies
and it does not apply to nonresidential repair and remodeling work.

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

You may call me toll free at 1-800-531-5441, ext. 5-0030. The direct line is
512/475-0030. You may also write to Tax Administration, Comptroller of Public
Accounts.

Sincerely,

David Somerville
Tax Administration Division