The Capital Improvement Quandary in New York
Berdon Tax Team
11.29.2017 | Berdon Industry Insights
While real estate and sales tax are not typically synonymous, New York property owners and management companies are prime targets for the New York State taxing authorities. As the New York City skyline continues to expand onwards and upwards, understanding the sales tax implications of this perpetual development is vital for companies doing business in New York. Knowing whether a project, or a portion thereof, constitutes either an exempt capital improvement or taxable repair and maintenance services can safeguard against costly and unexpected assessments or even misguided overpayments.
Capital Improvements vs. Repair and Maintenance Services
Capital improvements consist of any addition or alteration to real property that:
- Substantially adds value to the real property or extends the useful life of the real property;
- Is permanently affixed to the real property so that removal would cause material damage to the real property or article itself; and
- Is intended to become a permanent installation.
If a construction project meets all of the above criteria, it will be exempt from New York State sales and use tax. Prime examples of capital improvements are ground up construction projects and gut renovations of existing structures. With that said, it should also be noted that certain portions of these projects may not qualify for all facets of the exemption, as discussed below. Another example of a stand-alone capital improvement would be the removal and complete replacement of an existing roof.
Repair and maintenance is comprised of any work performed for the purpose of keeping real property in good working order, ensuring readiness, or restoring real property to such conditions, including repairing a crack in the roof of a building to prevent leaks. One significant type of repair and maintenance are installation services that involve setting up or putting into place tangible personal property, which remains tangible personal property after installation. Typical examples include the installation of appliances, such as washing machines, clothes dryers, and dishwashers.
If a project does not fit within the capital improvement exemption, then it will be classified as repair and maintenance or installation service and will be subject to sales tax.
What is Taxable and Who Pays the Tax?
Although the above rules seem straightforward, in practice they are more complex than they appear to be. Generally, the taxability of a construction project, and the bearer of the liability, depends on who performs the services as well as who purchases the materials.
For example, suppose that a property owner or management company purchases construction materials and tasks a building employee with performing the service. In this scenario, the materials are taxable upon purchase, regardless of whether or not the end result is a repair or capital improvement, while the labor is not taxable since it is performed by an employee in his or her employment capacity. However, if the same service was performed by a third party contractor, the taxability of the labor would depend on whether or not it constitutes a capital improvement.
In the more common case of a third party contractor performing the construction services as well as purchasing the materials, the taxability of the materials would depend on the classification the project. If the project qualifies as a capital improvement, the contractor is deemed the ultimate consumer of the materials and is responsible for paying sales tax on the materials at the time of purchase. The charge for the labor portion of the contract would not be subject to tax under the capital improvement exemption.
Alternatively, if the contractor performs repair and maintenance services, the property owner or management company is deemed the ultimate user of the materials and the contractor will charge sales tax on the materials to the property owner or management company. While the contractor still pays tax on its initial purchase of the materials, the contractor is entitled to claim a refund or credit of any tax paid on the materials used in the repair. Additionally, the charge for the contractor’s labor is also subject to sales tax.
Regardless of the type of project, someone will generally be responsible for paying tax on construction materials, with the exception of construction services that are performed for a tax-exempt organization.
Capital Improvement Traps
In order to claim the capital improvement exemption, the property owner or management company must provide the contractor with a properly completed Form ST-124, Certificate of Capital Improvement. The acceptance of the certificate in good faith typically relieves the contractor from charging sales tax on the project, however, does not mean that property owners and management companies are off the hook entirely.
The determination of what constitutes a capital improvement is frequently a focus of contention when under a sales and use tax audit in New York. While the larger aspects of the project are typically easier to uphold (e.g. installation of new walls and pipes or electrical wiring), there are certain services that are subject to tax, even when part of a larger capital improvement project. The most common examples include painting of existing walls, installation of carpet within an existing space, and the installation of free-standing cabinets and appliances.
The sales and use tax law relating to real property construction projects in New York contains many intricacies and nuances that property owners and management companies must be cognizant of. These rules should be carefully considered and discussed with a tax professional with experience in making appropriate determinations regarding taxability at the onset of any project, as minor errors can generate significant assessments upon audit due to the enormous costs associated with the construction and renovation of real property. These issues are imperative to developing and operating a business in New York.
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