When a contractor buys materials, supplies, or equipment for a construction or design contract where title passes to an exempt customer, when does the contractor owe Texas sales or use tax instead of claiming a resale exemption?

Plain-English summary

This letter combines two responses from the Texas Comptroller's Tax Policy Division (both signed by Wade Anderson) to a contractor asking how sales and use tax applies to materials, supplies, and equipment purchased under contracts where title to the property ultimately passes to an exempt customer — including cost-plus architectural/design contracts and fixed-unit-price construction contracts.

The starting point is the Texas Supreme Court's decision in Day & Zimmerman, Inc. v. Calvert, 519 S.W.2d 106 (Tex. 1975). Under that case, a contractor's or subcontractor's purchases and leases of property can qualify for the resale exemption — meaning no tax is owed by the contractor — if title to the property transfers to the exempt customer before the contractor makes any use of it. To rely on this, the contractor must also give the customer a list of the equipment transferred, mark the property "property of [customer]" when feasible, avoid depreciating the transferred equipment, and the equipment must remain the customer's property at the end of the agreement (unless the customer chooses to dispose of it). The Comptroller noted it construes Day & Zimmerman "strictly within the requirements set out in the decision."

The letter then works through the facts:

• Fixed-unit-price contracts (progress payments): The contracts stated that title to materials and work covered by progress payments passes to the customer when payment is made. But because payments were made after the contractor had already used the materials and supplies, and title did not pass before that use, tax was owed by the contractor on those materials and supplies. The letter separately confirms the general rule: if no use of property occurs before title actually transfers at the time of a progress payment, the property can be purchased for resale and no tax is owed — but whether use occurred before transfer is "a fact question."
• Equipment under fixed-unit-price contracts: These contracts did not separately state charges for equipment as Day & Zimmerman requires, so contractors operating under them could not claim the resale exemption on equipment purchased for use under the contracts, even if they met the decision's other requirements.
• Contractor use of equipment before title transfers, where a fair market rental value can be determined (the letter gives the example of a trenching machine or security lights): tax is owed only on that fair market rental value, not on the full purchase price of the item.
• Cost-plus architectural/design contracts: Title to reimbursable property passed to the customer upon the vendor's delivery, and title to other property passed upon issuance for contract use, commencement of processing, or cost reimbursement — whichever came first. Because title appeared to pass before the architects or design firms used the property, tax would not be owed on the materials, equipment, and supplies sold to the customer (assuming that timing was correct).
• Leases and rentals are different: Day & Zimmerman does not apply to leases or rentals because a lessee-contractor never holds title to convey to the customer, so the Comptroller could not confirm exemption for those items.

What this means for you

Contractors and subcontractors working under contracts with tax-exempt customers

Whether your material and equipment purchases qualify for the resale exemption turns entirely on timing: title to the property must pass to your exempt customer before you use it. If you use materials or equipment first and title only transfers later (for example, at a progress payment date), you owe tax on those items yourself — the resale exemption doesn't apply retroactively.

Contractors negotiating fixed-unit-price or cost-plus contracts

Structure your contracts to separately state and itemize equipment (not just materials and supplies), and make sure title transfer language actually causes title to pass before any contractor use — not merely at some later payment or billing event. Contracts that fail to separate equipment charges, or that pass title only after use has already occurred, will not support a resale exemption on that equipment or those materials.

Contractors who lease or rent equipment

Don't expect the Day & Zimmerman resale exemption to apply to leased or rented property. Because a lessee never holds title to the equipment, there's nothing to "transfer" to the customer, so this exemption path is unavailable for leases and rentals.

Accountants and tax professionals

When a fair market rental value can be determined for equipment used by the contractor before title passes (e.g., a trenching machine or security lights), tax is due only on that rental value rather than the full purchase price — a narrower tax base than treating the whole purchase as taxable.

Common questions

Q: Can a contractor buy materials tax-free for resale if the customer eventually gets title to them?
A: Only if title passes before the contractor uses the materials. If the contractor uses the materials or supplies first and title passes later (such as at a progress payment), tax is owed by the contractor on those materials and supplies.

Q: What if the contractor uses a piece of equipment before title transfers, but its rental value can be calculated?
A: Tax is owed on the fair market rental value of that use, not on the full purchase price of the equipment.

Q: Does the resale exemption apply to leased or rented equipment under Day & Zimmerman?
A: No. Day & Zimmerman does not apply to leases or rentals because the contractor/lessee has no title to convey to the exempt customer.

Q: Do fixed-unit-price construction contracts automatically qualify for the equipment resale exemption?
A: Not if the contract fails to separately state equipment charges as required by Day & Zimmerman. In that case, contractors cannot claim the resale exemption on equipment purchased for use under the contract, even if other requirements are met.

Q: What about cost-plus architectural and design contracts?
A: If title to the property passes to the customer before the architects or design firm use it (on delivery, issuance for use, commencement of processing, or reimbursement, whichever occurs first), no tax is owed on the materials, equipment, and supplies sold to the customer.

Citations and references

Case law:

• Day & Zimmerman, Inc. v. Calvert, 519 S.W.2d 106 (Tex. 1975)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9508501L

Original ruling text

ALERT: For specific guidance relating to the care, custody and control of TPP when providing a taxable service, please see Rule 3.285, Resale Certificates; Sales for Resale (amended 11/01/2017.

August 28, 1995

Dear *****:

On August 24, 1995, you wrote with further facts and questions concerning the
***** contracts. Your questions were as follows:

1. If title to the property purchased under "fixed unit price" contracts at the
   time of the progress payment but the contractor had not made any use of the
   property before the progress payment was made, is tax due on the sale to
   *****?

Answer: No. If no use of the property was made prior to transfer of title at
time of the progress payment, the property could be purchased for resale and no
tax would be owed by the contractor. It is a fact question as to whether a use
of the property has occurred before the transfer of title.

2. If the contractor makes use of the property before the title is transferred
   to ***** and a fair market rental value may be determined, is tax due on
   the fair market rental value or the entire purchase price of the item?

Answer: Tax is owed on the fair market rental value. This assumes that a fair
market rental value can be determined, e.g. the rental cost of a trenching
machine or security lights.

I hope this answers your questions. Call me if you have any further issues
regarding these contracts.

Sincerely,
Wade Anderson
Director
Tax Policy

August 11, 1995

Dear *****:

You asked us to confirm that:

In the case of contracts to provide nontaxable services to ** in which
title to property acquired by purchase or lease in the fulfillment of such
contracts vests in ** (such as in the case of the cost plus
architectural and design contracts and the fixed unit price construction
contracts excerpted above), pursuant to Day Zimmerman, v. Calvert, 519 S.W.2d
106 (Tex. 1975), such purchases and leases by contractors and subcontractors
are exempt from Texas sales and use taxes.

Under Day & Zimmerman, title to the property must transfer to **
before the contractor or subcontractor makes any use of the property, and the
contractor or subcontractor must provide * with a list of any
equipment so transferred. Property must be marked
"property of *" when feasible, and the contractor or subcontractor
must not depreciate equipment that it has transferred to *. The
equipment must remain the property of * at the end of the agreement
(unless *** chooses to dispose of it).

Day & Zimmerman does not apply to leases or rentals as contractors lessees do
not have title to convey to *****. Therefore, I cannot confirm your
statement in regard to these type items.

In your letter you explain that the fixed-unit price contracts (contracts to
improve realty) include schedules, which separately state estimated charges for
building materials, consumable supplies and all other charges. These contracts
generally provide that title to materials and work covered by progress payments
passes to ** when payments are made. Because the payments are made
after the contractor or subcontractor has used the materials and supplies and
title did not pass to ** before the progress payment, tax is owed by
the contractor or subcontractor on the materials and supplies.

The separated contract provisions for fixed-unit price contracts do not
separate charges for equipment as required by the decision. Therefore,
contractors or subcontractors operating under these agreements cannot claim
resale exemptions on equipment purchased for use under these contracts even
when they have met all other requirements outlined above.

** generally enters into cost-plus contracts with architects and
design firms. The cost-plus contracts provide that title to a property, for
which the program managers (architect or design firm) are entitled to be
reimbursed, passes to * upon the vendor's delivery. Next you say
that title to all other property shall pass to **** upon:

a. issuance of the property for use in contract performance,
b. commencement of processing of the property or use in the contract, or
c. reimbursement of the cost of the property, whichever occurs first.

It appears that title passes to ** before any use is made of the
property by the architects and design firms. Assuming this is correct, tax
would not be owed on the materials, equipment and supplies sold to **.

Our office continues to follow the Day and Zimmerman decision, but we construe
it strictly within the requirements set out in the decision.

I hope this satisfactorily answers your question. My number is 1-800-534-5441
extension 3-4004 if you have any further questions.

Sincerely,

Wade Anderson
Assistant Director
Tax Administration