This article will provide guidance on the exemption for incorporated materials used in performing real property improvements for a governmental entity or qualified religious, educational and public service nonprofit organization.
Buying Incorporated Materials
Certain incorporated materials can be purchased tax free when performing a real property improvement for governmental entities (under Section 151.309) or qualifying religious, educational and public service nonprofit organizations (under Section 151.310). This exemption applies even when the contract is between a nonexempt entity (such as a subcontractor) and a contractor if the contract is an “exempt contract.”
An exempt contract is a contract to improve real property for an exempt organization’s primary use and benefit as long as the improvements relate to the organization’s purpose. When the job’s primary use and benefit does not fulfill the exempt entity’s primary purpose, the exemption is lost.
A Texas public university, which is an exempt governmental entity, decides to lease property to a for-profit entity to build a dormitory for its students. The for-profit entity will purchase the construction materials under a construction contract with a contractor. The university will have control over the dormitory. Because the dormitory enhances the university’s educational operations, the dormitory fulfills the university’s exempt purpose. The for-profit entity may issue a properly completed exemption certificate to the contractor building the dormitory. The contractor can then provide an exemption certificate to their vendor instead of paying sales tax on the incorporated materials, qualifying consumables and qualifying taxable services.
A Texas private university that qualifies as an exempt organization decides to lease property to a for-profit entity to build retail space to lease to other businesses. The for-profit entity will purchase the construction materials under a construction contract with a contractor. The private university will have limited control over the property for the duration of the lease. The for-profit entity allows any patrons to shop at the retail space, and the businesses are able to use the retail space for their own general business needs such as rental revenue or selling items or services. Because the university will not primarily benefit from the retail space’s operation, the retail space is not for the primary use and benefit of the private university. The for-profit entity cannot give an exemption certificate to the contractor.
An exempt organization is not required to own the real property improvement, and the exemption can apply when the exempt organization leases the real property. If a taxable entity owns an improvement, such as a building, which is leased to an exempt entity, the exemption applies if the life of the lease equals or exceeds the expected useful life of the real property improvement.
If the life of the lease is less than the expected useful life of the real property improvement, then the exemption does not apply. If a lease between the owner and the exempt entity is for a specific period and the exempt entity has the option, but is not contractually obligated to renew the lease, the option is not considered when determining if the exemption applies.
For example, a Texas tax-exempt educational organization decides to lease an entire campus from a nonexempt entity. Under the lease, the property owner (lessor) acquires a site, constructs new facilities and leases the campus for 25 years. The planned improvements have an expected useful life of 22 years.
Because the lease is greater than the real property improvement’s expected useful life, the contract is making a real property improvement for the exempt entity and qualifies as an exempt contract. The educational organization can issue a properly completed exemption certificate to the contractor building the campus. The contractor can then provide an exemption certificate (PDF) to their vendor instead of paying sales tax on the incorporated materials, qualifying consumables and qualifying taxable services.