A private owner is building an office building specifically for a governmental Appraisal District, which is contractually obligated to buy the completed, improved property for its exclusive use once construction is done. Does the contractor performing this construction qualify for the sales tax exemption for improving real property for an exempt entity, even though the contract is technically between the owner and the contractor, not the District and the contractor?

Plain-English summary

A private property owner planned to build an office building specifically designed and approved for use as an Appraisal District's (a governmental/exempt entity's) offices. The structure of the deal: the owner would contract with a third-party contractor for the improvements, following plans and specifications the District itself approved; upon completion, the District would be contractually obligated to buy the finished, improved property for its sole use, with the purchase price partly based on construction cost. The owner asked the Comptroller to confirm the contractor performing this construction would qualify for the Tax Code Section 151.311 exemption for contracts to improve real property for an exempt entity — even though the contractor's actual contract was with the private owner, not directly with the District.

The Comptroller agreed the exemption applies. Because the improvements were being made at the exempt entity's request, built to its approved specifications, and would inure entirely to its benefit — with the District contractually bound to purchase the completed, improved property for its sole use — the Comptroller treated the arrangement as a genuine contract for improvement of realty for an exempt entity under Section 151.311. That let the private owner give its contractor an exemption certificate, and the contractor could in turn buy incorporated materials, certain taxable services, and consumable supplies tax-free by passing exemption certificates to its own suppliers and subcontractors.

The Comptroller flagged an important condition, though: the exemption is contingent on the sale to the District actually happening. If the District ultimately does NOT purchase the property, the exemption no longer applies, and tax becomes due on all the purchases made under it. The letter specifically advised that every party involved — the general contractor and all subcontractors, not just the owner — should be told about this contingency before finalizing their contracts.

What this means for you

Private developers building to spec for eventual sale to a government/exempt buyer

You can potentially pass through the Section 151.311 real-property-improvement exemption even though your contract with the exempt entity is indirect (you contract with a builder, the exempt entity contracts to buy from you afterward) — as long as the improvements are genuinely built at the exempt entity's request, to its specifications, for its exclusive benefit, and it's contractually committed to buy the finished property.

General contractors and subcontractors on build-to-suit government projects

Understand that your tax-free purchases under this kind of exemption are conditional on the ultimate sale to the exempt entity actually closing. If that sale falls through for any reason, tax becomes retroactively due on everything bought tax-free under the exemption — budget for that risk and get this contingency spelled out in your contracts before you start relying on exemption certificates.

Accountants and tax professionals structuring build-to-suit exempt-entity deals

This letter is a useful precedent for structuring a private-owner-to-government-buyer construction deal so that Section 151.311's exemption flows through despite the indirect contracting chain — but always build in the retroactive-tax contingency language for a failed final sale.

Common questions

Q: Can a contractor building for a private owner still get the government-contractor real property exemption, if the property is destined to be sold to a government/exempt entity?
A: Yes, per this letter — if the improvements are made at the exempt entity's request, to its specifications, for its exclusive benefit, and the exempt entity is contractually obligated to purchase the completed property.

Q: What can the contractor buy tax-free under this exemption?
A: Incorporated materials, certain taxable services, and consumable supplies, per Tax Code Section 151.311 — by giving exemption certificates to its own suppliers and subcontractors.

Q: What happens if the exempt entity ends up not buying the property?
A: The exemption no longer applies, and tax becomes due on all purchases made under it — a real retroactive risk that should be disclosed to all contracting parties in advance.

Q: Can I rely on this letter for my own build-to-suit government project?
A: No. It's based on the facts presented, and the letter notes the opinion may change on additional or different facts.

Citations and references

• Tex. Tax Code § 151.311 (exemption for contractors improving real property for exempt entities)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9804495L

Original ruling text

April 8, 1998

Dear Ms. **:

Thank you for your recent letter which is restated in part with response below.

My client, **a private owner, intends to enter into a contract to
construct a building for the ** Appraisal District to purchase upon
completion of construction. **will contract with a third-party
contractor for the improvements. The purchase price of the property will be in
part determined by the cost of construction of the required improvements. Upon
completion of the construction, the District will purchase the property for its
sole use. In the proposed transaction, the Owner will be contractually
obligated to construct the specific improvements required for use of the
building as the District's appraisal office in accordance with plans and
specifications approved by the District. Upon completion of such construction,
the District will be contractually obligated to purchase the property, as
improved, for its sole use as appraisal offices. The improvements will,
therefore, be made at the request of the exempt entity and will inure to its
benefit.

Please confirm that based on the proposed structure, the contractor will be
entitled to the tax exemption for the performance of a contract for the
construction and improvement of realty for an exempt organization.

Response: Based on facts you submitted, the contract to build the building is
considered to be a contract for the improvement of realty for an exempt entity
and will qualify for exemption under Tax Code 151.311. Accordingly, your
client may give an exemption certificate to its contractor. The contractor may
purchase tax free incorporated materials, and certain taxable services and
consumable supplies as provided in Tax Code 151.311 by giving its suppliers and
subcontractors exemption certificates in lieu of sales tax.

All parties should be aware that should the property not be purchased by the
District, the exemption will no longer apply, and tax will be due on all
purchases of taxable items. All parties involved, including the general
contractor and subcontractors, should be given this information before the
contracts are finalized.

This opinion is rendered 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. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division