How can a landlord allocate a lump-sum lease between taxable equipment and nontaxable real property for NY sales tax?

Plain-English summary

The petitioner is a REIT subsidiary that owns a hotel's real estate and its furniture, fixtures, and equipment (FF&E) and leases the whole package to an affiliated taxable REIT subsidiary for a single lump-sum rent. Leasing real property isn't taxable, but leasing tangible personal property (the FF&E) is -- so the petitioner asked whether its proposed method of carving out the taxable-equipment portion is acceptable.

The rules:
- When taxable property and real property are sold/leased for a single price, sales tax applies to the total (20 NYCRR 527.1(b)) unless a written contract sets out the allocation method or the invoice itemizes the equipment charge (Northway Properties, TSB-H-84(107)S).
- The amount allocated to the equipment must be reasonable -- it must approximate the fair market rental value of that equipment. A vendor has leeway in choosing a method (unless it also sells the same TPP separately, in which case its regular price controls).

The Office of Counsel's conclusion: the method may be accepted, but only on conditions -- and as proposed it wasn't shown to be reasonable. Using data from a reputable industry publication (the HVS Hotel Development Cost Survey) isn't per se improper, but the petitioner failed to establish reasonableness:

• It didn't show its hotel was "average" for FF&E value.
• It didn't justify reducing the survey FF&E figure by 60% as non-TPP fixtures (capital improvements like wallpaper, plumbing, installed lighting).
• It didn't account for indirect costs of leasing the equipment, like financing.

Two more guardrails: the method assumes the total rent equals the fair market rental value of the combined property -- and because the parties are affiliates, the petitioner must be ready to prove that on audit. And any method that yields a present-value receipt stream below the cost of the equipment is unreasonable. Finally, the tax must be separately stated on the first bill (Tax Law 1132(a)(1)).

Net: the HVS-based method may be accepted if (1) the assumptions are substantiated as reasonable, (2) the total rent is at fair market rental value, and (3) a written contract outlines the method or the invoice itemizes the equipment charge.

What this means for you

Landlords/lessors leasing real property bundled with equipment

A single rent covering real property and equipment is fully taxable unless you document an allocation -- in the contract or by itemizing the equipment charge on the invoice. The equipment number must be a reasonable, fair-market rental, and you should keep purchase records: an allocation that recovers less than the equipment's cost (present value) won't hold up.

Related-party leases

Affiliated lessor/lessee deals draw scrutiny. Be prepared to prove the total rent is at fair market value, or the whole allocation is suspect regardless of method.

Common questions

Q: I lease a building plus equipment for one price -- is it all taxable?
A: Yes, unless a written contract sets out the allocation or the invoice itemizes the equipment charge. Then only the reasonable, fair-market equipment portion is taxable.

Q: Can I use an industry cost survey to set the equipment portion?
A: It's not automatically improper, but you must show the method is reasonable -- that your property is typical, that your adjustments are justified, and that indirect costs are accounted for.

Q: We're affiliates -- does that matter?
A: Yes. You must be ready to substantiate on audit that the total rent is at fair market rental value, or the allocation is inherently flawed.

Citations and references

• Tax Law section 1105(a) (sales tax on receipts from tangible personal property)
• Tax Law section 1132(a)(1) (tax separately stated on the bill)
• 20 NYCRR section 527.1(b) (single price for taxable plus real property is fully taxable)
• 20 NYCRR section 532.1(b)(1) (tax separately stated)
• Petition of Northway Properties, TSB-H-84(107)S (allocation method; fair market rental value)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_2010.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a10_34s.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-10(34)S
Sales Tax
August 3, 2010

Office of Counsel
Advisory Opinion Unit
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S100219A

The Department of Taxation and Finance received a Petition for Advisory Opinion from name
and address redacted. Petitioner asks whether its proposed method of determining its receipts on the sale
of tangible personal property subject to sales tax is acceptable when it leases both tangible personal
property and real property to an affiliate.
We conclude that Petitioner’s use of data from a reputable industrial publication and reasonable
assumptions to determine the amount of receipts attributable to the lease of tangible personal property
may be accepted for purposes of sales tax provided: (1) Petitioner can substantiate that the assumptions
made in calculating the rental fee for tangible personal property are reasonable; (2) the total rent amount
for the tangible personal property and real property is the fair market rental value for the lease of the total
properties; and (3) a written contractual document outlines the method of calculation or the invoice billed
to the affiliate lessee contains an itemized charge for the lease of tangible personal property that is based
on the method.
Facts
Petitioner is the owner and landlord of a hotel property known as the name redacted which is
located at address redacted. Petitioner is a subsidiary of a qualifying real estate investment trust (REIT),
name redacted.
Federal tax laws limit the amount of non-qualifying income that can be earned by REITs,
including income derived directly from the operation of hotels. As a result, Petitioner owns the real estate
(land, buildings, and building improvements) and furniture, fixtures and equipment (FF&E) and leases
this property in its entirety to name redacted. (Lessee), a subsidiary designated as a taxable REIT
subsidiary. Lease payments are made in a lump sum, which includes rental for both real estate and
tangible personal property. The total rental amount is a base amount plus a percentage of revenue from
hotel operations.
Petitioner’s current method of calculating receipts from the lease of tangible personal property is
based on the net book value (NBV) of its FF&E as a percentage of its NBV for total assets. This
percentage is applied to total lease payments to yield receipts from the lease of tangible personal property.
Petitioner believes that this method overstates receipts from the lease of tangible personal property in part
because no adjustment is made for disposition of the tangible personal property in computation of NBV
for FF&E.
Petitioner proposes to change its method of calculating receipts from the lease of tangible
personal property by using data from a publication entitled “Hotel Development Cost Survey” published
by HVS International (HVS). These publications contain historic and current data on hotel costs.
According to a senior vice president of HVS, these survey publications have tracked hotel construction
costs throughout the United States since 1976. The surveys break data down by six types of lodging:
economic/budget hotels, midscale hotels without food and beverages, extended stay hotels, midscale

-2-

TSB-A-10(34)S
Sales Tax
August 3, 2010

hotels with food and beverages, full-service hotels and luxury hotels and resorts. Costs are presented in
the surveys on a per room basis.
HVS researches on an annual basis the developmental cost of actual hotel construction budgets,
industry reports, and uniform franchise offering circulars. These sources provide the basis for a range of
costs per room. New project construction cost data collected annually increases the range and/or impacts
the mean or median of construction cost components.
Petitioner believes that its hotel comes within the HVS survey category of “full-service hotel.”
The first step in Petitioner’s proposed method of calculating receipts from the lease of tangible personal
property would be to multiply the number of rooms in its hotel (460) by the median value listed for FF
&E in the full service hotel category of the current HVS survey. This computation would be updated
annually.
Because FF&E amounts listed in the HVS surveys include fixtures that qualify as capital
improvements for purposes of sales tax (e.g., wallpaper, window and door frames, showers, toilets, sinks,
vanities, and installed lighting fixtures), Petitioner proposes to reduce the FF&E amount per room listed
in the applicable HVS survey by 60% based on its estimate that tangible personal property is 40% of the
total FF&E amount.
Adjusted FF&E cost (estimated total tangible personal property cost) would be divided by total
hotel cost to yield a percentage, which would be applied to total lease payments owed by the Lessee to
determine receipts on the lease of tangible personal property. This calculation would be updated
annually.
Analysis
Tax Law section 1105(a) imposes sales tax on the receipts for the sale of tangible personal
property. Sales tax regulation section 527.1(b) provides that when tangible personal property composed
of taxable and exempt items is sold as a single unit, the tax shall be collected on the total price. The same
result applies when a vendor sells tangible personal property and real property for a single price.
Petitioner, thus, must collect sales tax on its total lease receipts unless a written contractual document
outlines the method of allocating receipts or the invoice billed to the Lessee contains an itemized charge
for the lease of tangible personal property. See Petition of Northway Properties, State Tax Commission,
July 31, 1984, TSB-H-84(107)S.
The lease amount charged by Petitioner for tangible personal property must be reasonable in that
it must approximate the fair market rental value for the lease of the tangible personal property. Id. The
Department does not dictate how a vendor sets the sales price for tangible personal property, as long as
the price is reasonable. Thus, a vendor has some leeway in selecting a method for determining the price
for the sale of tangible personal property that is sold in conjunction with real property, provided that the
vendor does not also sell the tangible personal property separately. (If the vendor does sell tangible
personal property separately, the vendor’s regular price for tangible personal property sold alone should
be used when the tangible personal property is sold with real property.)
While the use of data from a reputable industrial publication to determine the charge for the lease
of tangible personal property is not per se impermissible, Petitioner has not established that its proposed
method of setting the lease price for tangible personal property is reasonable. Petitioner has not offered
any affirmative reasons for concluding that its hotel is average in regard to the value of its tangible

-3-

TSB-A-10(34)S
Sales Tax
August 3, 2010

personal property. Nor has Petitioner offered any explanation why it believes 60% of the purchases in the
HVS category for FF &E represent fixtures that are not tangible personal property for purposes of New
York sales tax. Finally, Petitioner has failed to explain how it will be accounting for indirect costs of
leasing tangible personal property, such as financing. Therefore, it is not possible to opine on whether
Petitioner’s proposed method of using the HVS study is reasonable.
Petitioner’s proposed method of determining charges for the lease of tangible personal property is
premised on the total price charged for the lease of both tangible personal property and real property
equaling the fair market rental value of the combined rental property. If the total rental price is not at fair
market rental value, Petitioner’s proposed method of determining charges for the lease of tangible
personal property would be inherently flawed, irrespective of the caveats noted above. Because Petitioner
and its lessee are affiliates, Petitioner should be prepared on audit to substantiate that its total lease
charges are at fair market rental value.
As indicated above, the goal of any method of setting the price for the lease of taxable tangible
personal property should be to approximate the fair market rental value of the property leased. Any
method of setting the lease price for the tangible personal property that yields a total receipt stream at
present value that is less than the cost of the tangible personal property would not be reasonable.
Therefore, Petitioner should maintain all necessary records, including purchase records for tangible
personal property, so that the Department on audit can verify that Petitioner’s lease charges are at fair
market rental value and that Petitioner is leasing the tangible personal property at an amount that
reasonably reflects the cost of the tangible personal property.
While the amount of the taxable receipts or the method of determining taxable receipts may be
delineated on any contractual document, the sales tax due must be stated, charged, and shown separately
on the first sales slip, receipt, or other statement of price given the customer. Tax Law, §1132(a)(1), 20
NYCRR §532.1(b)(1).

DATED: August 3, 2010

NOTE:

/S/
Jonathan Pessen
Director of Advisory Opinions
Office of Counsel

An Advisory Opinion is issued at the request of a person or entity. It is limited to
the facts set forth therein and is binding on the Department only with respect to
the person or entity to whom it is issued and only if the person or entity fully and
accurately describes all relevant facts. An Advisory Opinion is based on the law,
regulations, and Department policies in effect as of the date the Opinion is issued
or for the specific time period at issue in the Opinion.