Construction and Sales Tax
The applicability of sales tax to real property, that is construction labor and building materials permanently “attached” to real property, is very different from the taxability of tangible personal property. Generally speaking, tangible personal property is taxable, with certain common exceptions including groceries, agricultural and manufacturing equipment and inputs, and sales for resale.
In contrast, the majority of states treat construction contracts as exempt services, with contractors paying sales or use tax on all materials. A few states treat real property contracts as completely taxable (Washington), partially taxable on all receipts (Arizona), or subject to a special contractor’s tax (Mississippi, South Dakota). A few states distinguish between contracts for new and existing (i.e. remodeled or repaired) structures (Texas), or commercial and residential structures (Connecticut, Mississippi); and a few others base taxability on whether the contract is for a lump sum, or breaks out time and materials (Indiana). Sometimes prime contractors and subcontractors are treated differently – and in some cases a subcontractor charges might be considered “re-sold” by the prime contractor.
Not all services to real property are considered exempt real property contracting. Repairs to a structure that do not result in a capital improvement are taxable in a few states (New Jersey, New York). Labor that is considered “maintenance” might also be taxable (District of Columbia, West Virginia). For example, landscaping, where the features of a yard or other outdoor area are modified, and plants are altered or added, is usually treated as contracting; lawn care which trims, fertilizes, and waters an existing landscape is a maintenance activity.
In the states where construction contracts are exempt from sales tax, the contractor is considered the end user of building materials, and pays sales tax (or owes use tax) on all building materials used in the project. The contractor may include sales or use tax in the bid proposal, but not as a separately stated item. This arrangement is similar to the treatment of many other service providers, who pay tax on the materials they use in providing exempt services. For example, in states where TPP repair service is exempt, repairpersons pay sales tax on the parts they use in providing their services.
Contractors will often keep an “inventory” of building materials which they acquire tax free for resale, and then accrue use tax as they withdraw materials for particular contracts. In a state where only residential construction is exempt, or only new construction is exempt, it is very important for builders to keep good records of which materials are used in which project. In many cases where a construction contract is taxable, the building materials used in the project are accordingly exempt to the builder and taxable to the property owner, so that in addition to not accruing use tax on those materials, the contractor should collect and remit sales tax from the owner. Connecticut and Kansas provide scenarios in which construction labor is taxable to the customer, but the materials are not.
In a number of states, if the customer is a tax-exempt entity, such as a non-profit or governmental body, the exemption for building materials might be available to the contractor making purchases on the entity’s behalf. If the customer’s exemption is not available to the building contractor, the contractor might be able to realize a tax savings if the exempt entity or its authorized agent purchases materials itself. It is important to be aware of the regulations around this type of arrangement, and all contracts involving real property, so as to avoid liability under audit.