Is removing an old lighting system and installing a new hardwired energy-efficient one a capital improvement, so the contractor doesn't charge the customer sales tax?

Plain-English summary

A contractor (Energy Saving Technologies) removes a building's old lighting and installs a new, more efficient system that meets a utility's efficiency specifications (the utility pays the customer a rebate per fixture replaced). The new system uses about half the energy of the old one, is worth close to double the cost of merely replacing the old system, is permanently hardwired into the building's electrical wiring, and has a life expectancy of decades. The contractor supplies both materials and labor and asked whether this work is a capital improvement.

New York (Tax Law § 1101(b)(9); regulation 20 NYCRR § 541.2(g)) treats an addition or alteration to real property as a capital improvement when it (i) substantially adds value or appreciably prolongs the useful life of the property, (ii) becomes part of or is permanently affixed to the property so that removal would cause material damage, and (iii) is intended as a permanent installation.

The Department held that the described installed lighting system meets that test and is a capital improvement. The practical tax consequences under the contractor rules:

• The contractor does not charge the customer sales tax on the job, provided the customer gives the contractor a properly completed Form ST-124, Certificate of Capital Improvement (20 NYCRR § 541.5(b)(2)).
• The contractor owes sales or use tax on the cost of its materials, because a contractor making a capital improvement is the ultimate consumer of the tangible personal property that goes into the job (20 NYCRR § 527.7(b)(5)).

What this means for you

Contractors doing capital-improvement work

When your installation genuinely meets the three-part § 1101(b)(9) test — real added value or prolonged life, permanent affixation with material damage on removal, and permanence of intent — the customer's charge is a nontaxable capital improvement. Collect a Form ST-124 from the customer to support not charging tax, and remember the flip side: you pay tax on the materials you buy and consume in the job, so price that cost in.

Building owners upgrading permanent systems

A permanently hardwired system replacement (like this lighting retrofit) can be a nontaxable capital improvement rather than a taxable purchase-and-install. You'll give the contractor a capital-improvement certificate. Don't expect the contractor's material costs to be tax-free, though — that tax is embedded in the contract price.

Accountants and tax professionals

This is a straightforward application of the contractor capital-improvement scheme: § 541.5(b)(2) relieves the customer charge when a Form ST-124 is furnished, while § 527.7(b)(5) taxes the contractor as consumer of the materials. The facts hit all three § 1101(b)(9) prongs cleanly — permanent hardwiring, decades-long life, and substantial added value.

Common questions

Q: Is replacing a building's lighting system a capital improvement?
A: On these facts, yes. The new system was permanently hardwired, expected to last decades, and substantially added value, meeting the three-part test in Tax Law § 1101(b)(9), so the Department treated it as a capital improvement.

Q: Does the contractor charge the customer sales tax?
A: No — provided the customer furnishes a properly completed Form ST-124, Certificate of Capital Improvement. Then the charge for the capital improvement isn't subject to tax (20 NYCRR § 541.5(b)(2)).

Q: Does anyone pay sales tax on the job?
A: Yes. The contractor owes sales or use tax on the cost of the materials used, because a contractor making a capital improvement is the ultimate consumer of that tangible personal property (20 NYCRR § 527.7(b)(5)).

Q: What makes something a capital improvement?
A: Under § 1101(b)(9), it must substantially add value or appreciably prolong the property's useful life, become part of or be permanently affixed so removal causes material damage, and be intended as a permanent installation.

Q: Can another contractor rely on this opinion?
A: No. An advisory opinion binds the Department only as to the petitioner and the facts described; another taxpayer with different facts cannot rely on it.

Citations and references

Statutes and authorities:

• Tax Law § 1101(b)(9) (definition of capital improvement)
• Tax Law § 1105(a) (tax on retail sales of tangible personal property)
• 20 NYCRR § 541.2(g) (regulatory definition of capital improvement)
• 20 NYCRR § 541.5(b)(2) (capital-improvement charges not taxed when the customer furnishes a certificate)
• 20 NYCRR § 527.7(b)(5) (contractor pays tax on the cost of materials for a capital improvement)
• Form ST-124 (Certificate of Capital Improvement)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1992.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a92_81s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-92 (81) S
Sales Tax
November 27, 1992

Taxpayer Services Division
Technical Services Bureau

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S920814A

On August 14, 1992 a Petition for Advisory Opinion was received from Energy Saving
Technologies, Inc., 15 Rector Court, Bergenfield, New Jersey.
The issue raised by Petitioner, Energy Saving Technologies, Inc., is whether the removal of
an existing lighting system and replacing it with a new lighting system qualifies as a capital
improvement.
A business which is one of Petitioner's customers is removing a lighting system in order to
upgrade to more efficient lighting. The power company will rebate to the customer a specific amount
for each fixture system replaced. The old fixture must be completely removed and replaced with a
system which meets the power company's efficiency specifications.
The new lighting system provides similar light levels while using half the energy of the
existing system. The new lighting system has a value that is close to double the cost of what the
existing lighting system could be replaced for. The lighting system will be permanently affixed to
the real property as each fixture is hardwired into the building's electrical wiring and has a life
expectancy of decades. The contractor is providing both the materials and the labor in connection
with the installation of the system.
Section 1105(a) of the Tax Law imposes a tax on the receipts from every sale of tangible
personal property.
Section 1101(b)(9) of the Tax Law and Section 541.2(g) of the Sales and Use Tax
Regulations defines a capital improvement as an addition or alteration to real property which (i)
substantially adds to the value of the real property, or appreciably prolongs the useful life of the real
property; and (ii) becomes part of the real property or is permanently affixed to the real property so
that removal would cause material damage to the property or article itself; and (iii) is intended to
become a permanent installation.
Section 541.5(b)(2) of the Sales and Use Tax Regulations states:
Labor and material charges. All charges by a contractor to the customer for adding
to or improving real property by a capital improvement are not subject to tax
provided the customer supplies the contractor with a properly completed certificate
of capital improvement.
Section 527.7(b)(5) of the Sales and Use Tax Regulations states:
Any contractor who is making a capital improvement must pay a tax on the cost of
materials to him, as he is the ultimate consumer of the tangible personal property.

-2­
TSB-A-92 (81) S
Sales Tax
November 27, 1992

When a contractor sells a complete installed lighting system as described above it is
considered to be performing a capital improvement, as such installation meets the definition of a
capital improvement as defined in Section 1101(b)(9) of the Tax Law and Section 541.2(g) of the
Sales and Use Tax Regulations. Accordingly, the contractor will not be required to collect sales tax
on the charges to the customer for the lighting system, provided the customer furnishes the
contractor with a properly completed Form ST-124, Capital Improvement Certificate. However, the
contractor will be liable for sales or use tax on the cost of the materials used in the lighting system
pursuant to Section 527.7(b)(5) of the Sales and Use Tax Regulations.

DATED: November 27, 1992

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.