If a lessor leases a building along with tangible personal property inside it (like computer equipment) for one combined rent with no separate charge for the equipment, is any part of the rent subject to Texas sales tax?

Plain-English summary

A building owner had discontinued its third-party data processing operations and was left with a building plus fixtures and equipment inside it -- including computer hardware and installed software -- that it had bought and paid tax on. It wanted to lease part of the building to a new tenant, bundling in all the tangible personal property (including that computer equipment) situated in the leased space, for one combined rent with no separate line-item charge for the equipment. The Comptroller ruled that no Texas sales or use tax is due on any part of that rent. Under Rule 3.294(k)(1), when a real property lease also includes tangible personal property as part of the same agreement, the whole thing is treated as a nontaxable lease of real property -- the same rule that lets someone rent a furnished apartment without paying sales tax on the portion of rent tied to the furniture. The letter cites the Comptroller's own prior rulings applying this same rule to a car-wash building leased with its car-wash equipment (nontaxable) and to standalone equipment rental like a sand-and-gravel plant (taxable when NOT bundled with real property). Because the lessor already paid tax on the equipment and fixtures when it originally bought them -- and Rule 3.294(k)(1) doesn't allow a resale certificate for that kind of purchase -- there is no additional tax due when it leases the property out.

What this means for you

Commercial landlords bundling equipment into a real estate lease

If your lease charges one combined rent for a building/space plus tangible personal property inside it (furniture, computer equipment, fixed machinery) with no separate charge broken out for the equipment, Rule 3.294(k)(1) treats the whole arrangement as a nontaxable real property lease. But you still owe sales/use tax yourself when you originally buy that equipment -- you cannot use a resale certificate to defer that tax based on your intent to lease it out bundled with real estate.

Businesses leasing standalone equipment (not bundled with real property)

The flip side matters too: equipment rented on its own, without a real property lease wrapped around it, is taxable as a lease of tangible personal property -- illustrated in the letter by the sand-and-gravel-plant example.

Accountants and tax professionals

The controlling test under Rule 3.294(k)(1) is whether the tangible personal property lease is bundled into the SAME agreement as the real property lease with no separate charge -- not the nature of the property (data processing computer equipment worked the same way as furniture or car-wash equipment in prior applications of this rule).

Common questions

Q: Is rent taxable when a building lease includes equipment located in the space, with one combined rent and no separate equipment charge?
A: No, per this letter -- Rule 3.294(k)(1) treats it as a nontaxable real property lease.

Q: Does the landlord/lessor owe any tax at all in this situation?
A: Yes, per this letter -- the lessor must pay sales/use tax when it originally purchases the tangible personal property; a resale certificate cannot be used for that purchase under Rule 3.294(k)(1).

Q: What if the tangible personal property is rented on its own, without a real property lease?
A: Per this letter's discussion of a sand-and-gravel-plant ruling, standalone equipment rental (not bundled with a real property lease) is taxable.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code Rule 3.294(k)(1) (lease of tangible personal property bundled with a real property lease)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9705476L

Original ruling text

May 21, 1997

Dear ***:

This is in response to your request for a ruling on behalf of your client. You
are requesting a written ruling regarding whether Texas sales and use tax is
due under the following lease transaction. I have restated your facts regarding
the transaction and discussion of the relevant legal authorities below. Your
ruling request is in Section III, followed by my response.

I. FACTS

Our client ("Lessor") is contemplating a lease transaction. Lessor owns a
building and the land upon which the building is built (the "Building'). Most
of the Building was previously used by Lessor in its third-party data
processing operations.

Located in the Building are fixtures and tangible personal property owned by
Lessor that were previously used by Lessor in its third-party data processing
operations, including computer hardware and software installed on the computer
hardware (collectively, the "Computer Equipment").

At the end of 1996, Lessor discontinued its third-party data processing
operations. Lessor now intends to enter into a Facility Lease Agreement (the
"Facility Lease") with a lessee (the "Lessee"), under which Lessor leases a
portion of the Building to the Lessee along with all the tangible personal
property situated within that portion of the Building including the portion of
the Computer Equipment located within the portion of the Building being leased.

The rent payable under the Facility Lease covers the Building and all other
property included under the Facility Lease (that is, there are no separate
charges for the Computer Equipment or any of the other tangible personal
property included under the Facility Lease).

A resale certificate was not issued at the time the Computer Equipment and the
other tangible personal property being leased under the Facility Lease was
purchased and sales or use tax was paid at the time that tangible personal
property was purchased.

II. DISCUSSION

Comptroller's Rule 3.294(k)(1)

Lessor's lease of a portion of the Building and the tangible personal property
situated in that portion of the Building (including the Computer Equipment)
under the Facility Lease is addressed in 34 Texas Administrative Code Sec.
3.294 (hereinafter cited as "Rule 3.294"). That rule provides that "[i]f a
contract for the lease or rental of real property includes the lease or rental
of tangible personal property (such as furniture) as part of the agreement, no
sales tax is due on the amount charged the tenant for the lease or rental of
the tangible personal property." Rule 3.294(k)(1). The rule also states that a
resale certificate may not be issued and sales or use tax must be paid at the
time the tangible personal property was purchased. Rule 3.294(k)(1).

The Comptroller's office has applied this rule recently in a ruling dated
November 20, 1996 (a copy of which is attached as Exhibit 1). This ruling was
in response to a taxpayer who requested a ruling from the Comptroller's office
regarding a lease of car wash equipment (which is tangible personal property)
with a car wash building and the land on which the building was built. The
ruling from the Comptroller's office states that:

• The lease of the land, building, and equipment . . . is considered the lease
  of real
  property and is not subject to sales tax. This is based on the same provision
  in the tax
  law that allows a person to rent a furnished apartment without having to pay
  sales tax
  to his landlord on the portion of the rent relating to the furniture each
  month.

The Comptroller's November 20,1996 ruling discussed above is similar to a
ruling dated September 1, 1988 (a copy of which is attached as Exhibit 2),
which also applied the rule now in Rule 3.294(k)(1). This ruling was in
response to a taxpayer who requested a ruling from the Comptroller's office
regarding the rental of sand and gravel plant equipment (which is tangible
personal property). This ruling concludes that:

The rental of tangible personal property such as a sand and gravel plant is
taxable.
However, the lease of a sand and gravel plant would not be taxable if the
contract for the lease includes the lease of real property.

Facility Lease

Rule 3.294(k)(1):

The Facility Lease is the type of lease contemplated by

1. The Facility Lease contract:

(a) is for the lease or rental of a portion of the
Building, which is real
property; and
(b) includes as part of the agreement the lease or rental
of all the tangible personal
property situated in the portion of the Building being leased-(including the
Computer Equipment); and

2. Lessor owns the Building (that is, the real property in which
   the Computer
   Equipment and other tangible personal property is situated).

Consequently, under Rule 3.294(k)(1), Lessor should not be required to collect
Texas sales or use tax on any portion of the rent payable to Lessor by the
Lessee under the Facility Lease.

III. RULING REQUESTED

Based on the information provided herein, our client respectfully requests a
ruling from the Comptroller that no Texas sales or use tax is due on any
portion of the rent payable by the Lessee under the Facility Lease to Lessor.

RESPONSE: Pursuant to Rule 3.294(k)(1), no sales tax is due on any portion of
the rent payable by the Lessee under the Facility Lease to the Lessor.

This opinion is based on the facts presented. Other facts though similar may
provide a different result.

I hope this information answers your questions. If you need additional
information, please
call me toll-free at 1-800-531-5441, extension 3-4502. The direct line is
512/463-4502. You may also write to Tax Policy Division, Comptroller of Public
Accounts. My Internet address is: [email protected].

Sincerely,

Gilbert Zamora
Tax Policy Division