When a contractor demolishes an old septic system and installs a new sewer line tying into the city system, which parts of the job are taxable repair/remodeling and which are nontaxable new construction or demolition?

Plain-English summary

The Texas Comptroller split a single sewer-line replacement project into four separately taxed pieces, illustrating how granular the taxable-vs-nontaxable line can get on a real property construction job in Texas: new pipe installation was nontaxable new construction, complete demolition of the old system was nontaxable, but tying the new pipe into the old grease trap and repairing the parking lot were both taxable remodeling — even on the very same invoice.

The property owner decommissioned an old septic system in favor of a new city sewer connection. The contractor's invoice separately billed for: (1) installing a new sewer line from the grease trap to the city tie-in, through a brand-new trench in a different direction than the old pipe ran; (2) completely demolishing the old septic tank and its connecting pipe; (3) connecting the new line to the existing grease trap; (4) saw-cutting, removing, and repouring parking-lot concrete disturbed by the trenching; and (5) a pass-through city permit fee. Each got a different tax answer. New construction (digging a fresh trench and laying new pipe not connected to or built within an existing structure) is nontaxable, even if built within an existing property's footprint — here, a genuinely new sewer line running in a new direction. Complete demolition of an existing nonresidential improvement (the whole septic tank system) is neither taxable remodeling nor modification. But tying the new line into the pre-existing grease trap is taxable remodeling — connecting new work to something old is the taxable act, even when the new work itself was nontaxable construction. Likewise, the separately billed concrete repair of the disturbed parking lot is taxable nonresidential real property repair. Finally, the dollar-for-dollar permit-fee pass-through, being separately stated, is a nontaxable "unrelated service" under the Comptroller's stand-alone-service test.

What this means for you

Contractors doing utility tie-in, demolition, and site work

Break out your invoice by activity type and bill each piece separately. New construction (digging fresh trenches, laying brand-new lines unconnected to old work) is nontaxable; complete demolition of an old structure is nontaxable; but ANY tie-in point where new work connects to existing infrastructure becomes taxable remodeling, even on the same job. Combining everything into one lump sum without separate line items risks making the WHOLE charge taxable if the repair/remodeling portion isn't kept to 5% or less and separately stated.

Property owners hiring contractors for utility upgrades or demolition-plus-construction projects

Ask your contractor to separately itemize new-construction work, complete-demolition work, and any tie-in/connection work — the tax treatment genuinely differs line by line, and lump-sum billing without separation can turn otherwise-nontaxable work taxable.

Accountants and tax professionals

The controlling framework is 34 Tex. Admin. Code § 3.357: subsection (a)(8) (new construction), (a)(11) (complete vs. partial demolition), (a)(15) (unrelated-service, three-part test), and (b)(2)-(3) (the 5%-rule and separate-statement requirements for mixed contracts). Note the standing "new pipeline tie-in is taxable remodeling" rule from Comptroller's Decision No. 29,731 (1996), applied consistently here even though the surrounding new-construction work was nontaxable.

Common questions

Q: If I install a brand-new pipeline that connects to an existing structure, is the whole job nontaxable new construction?
A: No. The new-construction portion (digging the new trench, laying the new line) is nontaxable, but the specific act of tying the new line into the existing structure is taxable remodeling — these can be billed and taxed separately.

Q: Is complete demolition of an old structure always nontaxable?
A: Yes, per 34 Tex. Admin. Code § 3.357(a)(11) — complete demolition of an existing nonresidential improvement is neither taxable remodeling nor modification, unlike PARTIAL demolition, which is taxable remodeling.

Q: Are city permit fees passed through to a customer taxable?
A: No, if separately stated as a dollar-for-dollar reimbursement, a city permit fee qualifies as a nontaxable "unrelated service" under the Comptroller's three-part stand-alone-service test.

Q: Can another property owner or contractor rely on this ruling?
A: No. Because the requester didn't disclose its identity, this ruling carries no detrimental-reliance protection for anyone, including the requester — it illustrates the Comptroller's reasoning, not a rule you can invoke directly.

Citations and references

Statutes and rules:

• Tex. Tax Code § 151.0101(a)(11), (13) (Taxable Services — real property services; repair/remodeling)
• Tex. Tax Code § 151.007(a) (Sales Price, definition)
• 34 Tex. Admin. Code § 3.357(a)(8) (new construction); (a)(11) (complete vs. partial demolition); (a)(15) (unrelated service, three-part test); (b)(2)-(3) (mixed-contract taxability and 5% rule)
• 34 Tex. Admin. Code § 3.291(a)(9) (Contractors — new construction)
• Comptroller's Decision No. 28,070 (1993); No. 32,894 (1996) (stand-alone new construction within an existing footprint)
• Comptroller's Decision No. 29,731 (1996) (pipeline tie-in is taxable remodeling)
• Comptroller's Decision No. 107,120 (2014); No. 101,939 (2011) (permit-fee reimbursement, nontaxable unrelated service)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/201801015L

Original ruling text

January 12, 2018

Attorney at Law **

ADDRESS

CITY, Texas 78759

RE: Private Letter Ruling No. 2017010124

Unnamed Taxpayer

Dear **:

We issue this private letter ruling in accordance with Rule 3.1, Private Letter Rulings and General Information Letters, in response to your request dated Oct. 25, 2016.[ENDNOTE: 1] The identity of the entity to which this request relates was not disclosed. As noted in Rule 3.1(c)(1)(A), detrimental reliance relief is not provided if the identity of the entity to which the request relates is not revealed.

You requested guidance on the taxability of labor or lump sum services provided by a contractor on existing commercial realty for the unnamed taxpayer (Taxpayer).

Facts Presented

Taxpayer’s existing commercial realty includes a building, a grease trap, and a septic system. When the city installed waste water lines throughout the city, Taxpayer wanted to decommission the septic system and tie into the new sewer line. Taxpayer hired a contractor to demolish its septic tank, which together with the drain field was abandoned and left underground, and to install new piping to tie into the new sewer line.

The submission states that contractor demolished the septic tank in accordance with applicable environmental regulations. The demolition services included the demolition of the pipeline from the septic tank to the existing grease trap of the existing building. The new line from the grease trap to the city sewer was connected to the same outlet on the grease trap as was the previous line that went to the septic tank.

The contractor dug a new trench and installed new piping, which runs from the grease trap to the city’s tie-in under the existing parking lot. The contractor saw cut the old concrete of the lot, removed it, dug a ditch, laid new pipe, and then poured new concrete to replace the demolished concrete.

A diagram depicting the scope of work shows that the new sewer line leading from the grease trap to the city tie-in goes in a different direction than the demolished pipe, which led from the grease trap to the septic tank.

The ruling request also contains the contractor’s invoice showing separately stated charges for the following:

Install new sewer from grease trap to tap;

Destroy existing septic system;

Saw cut, remove, and pour back existing concrete;

Additional grease trap work--connect existing grease trap to new line; and

Permit fee.

The permit fee is charged because the contractor obtained a building permit from the city and billed Taxpayer for the building permit fees.

Questions, Rulings, and Analysis

Our restatement of your questions is below, followed by our responses and analysis.

Question One: Is the installation of the new sewer line nontaxable new construction?

Ruling One: Yes, the installation of the new sewer line is new construction, and the labor is not taxable. The labor charge for additional grease trap work to connect the new line to the existing grease trap line is nonresidential real property repair, remodeling, or restoration, and the labor is taxable.

Analysis: Real property services and real property repair and remodeling are taxable services. Sections 151.0101(a)(11), (13) (Taxable Services); Rule 3.357(b) (Nonresidential Real Property Repair, Remodeling, and Restoration; Real Property Maintenance). However, all new improvements to real property, including initial finish- out work to the interior or exterior of the improvement are new construction and are not taxable repair or remodeling. Rules 3.291(a)(9) (Contractors) and 3.357(a)(8).

The services provided by the contractor include digging a new trench where none is currently located and installing new pipe in the new trench to tie into the city sewer line. The facts presented also show that the new pipeline would become the sewer line of the existing building. Comptroller’s Decision No. 28,070 (1993), states that the fact that a stand-alone unit was built for a specific purpose is sufficient to deem the project new construction even if the unit was built within the footprint of an existing property. See also Comptroller’s Decision No. 32,894 (1996), which stated that when a job entails stand-alone new construction unconnected to and requiring no work on the surrounding, existing structure, it is new construction and not real property repair, remodeling, or restoration. Therefore, the digging of the new trench and the installation of the new sewer line is nontaxable new construction.

The invoice shows a separate charge from the contractor for “Additional grease trap work--connect existing grease trap to new line.” The tie-in of a new improvement to existing real property, however, is taxable. See Comptroller’s Decision No. 29,731 (1996) which states that “[T]he tie-in (i.e., welding) of a completely new pipeline or replacement pipeline sections (the latter, either in the same or a new ditch) to the old pipeline sections has consistently been viewed as the taxable remodeling of real property.”

Question Two: Is the demolition of the septic tank system a nontaxable service?

Ruling Two: Yes, the complete demolition of the septic tank and the pipe from the septic tank to the grease trap is a nontaxable service.

Analysis: Rule 3.357(a)(11) states “Partial demolition of existing nonresidential realty is taxable remodeling. The complete demolition of an existing nonresidential improvement to real property is neither remodeling nor modification and is not taxable.”

Question Three: Taxpayer acknowledges that saw cutting, removing, and pouring back existing concrete is taxable repair and remodeling of the existing parking lot even though the trenching and addition of a pipe underneath the parking lot is new construction. However, if this charge is combined with the construction of the new pipeline and the concrete work constitutes less than 5% of the lump sum charge for installing the new pipeline, is the lump sum charge taxable?

Ruling Three: The taxability of a lump sum charge depends upon whether the requirements of Rule 3.357(b)(3) are met.

Analysis: Rule 3.357(b)(3) states that a contract that involves both nonresidential repair, restoration, or remodeling and new construction is taxable in total unless the charge for new construction labor is separately stated to the customer. Minor repair, restoration, or remodeling that is performed in connection with new construction is not taxable if the portion of the charge attributed to repair, restoration, or remodeling is 5% or less of the overall lump sum charge. All separately stated charges for repair, restoration, remodeling, or other taxable services are taxable, even if they constitute 5% or less of the total contract price.

The facts presented in Question 3 are not the facts presented in this request. The charge to saw cut, remove, and pour back existing concrete was separate from the charge for the new construction of the sewer line on the invoice provided; therefore, the charge to repair the parking lot is taxable.

Question Four: Are charges to reimburse contractor for city permit fees taxable?

Ruling Four: Dollar-for-dollar reimbursements for city permit fees are not taxable when separately stated to the customer.

Analysis: The sales price of a taxable item means the total amount for which a taxable item is sold, leased, or rented, valued in money, without a deduction for the cost of materials used, labor or services employed, or other expenses. Section 151.007(a). Persons who repair, restore, or remodel nonresidential real property must collect sales tax on the total sales price to the customer less separately stated charges for unrelated services. Rule 3.357(b)(2).

A service is “unrelated” if: (1) it is not the repair, remodeling, or restoration of nonresidential real property, nor a service or labor that is taxable under the Tax Code, Chapter 151; (2) it is of a type that is commonly provided on a stand-alone basis; and (3) the performance of the service is distinct and identifiable. Rule 3.357(a)(15).

The Comptroller previously determined that a separately stated dollar-for-dollar reimbursement for a city building permit is a nontaxable unrelated service under Rule 3.357(a)(15). See Comptroller’s Decision Nos. 107,120 (2014) and 101,939 (2011).

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling No. 2017010124.

Sincerely,

Tax Policy Division - Indirect Taxes

Texas Comptroller of Public Accounts

ENDNOTE:

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.