A privately owned building is leased to a tax-exempt entity, and the owner plans a 12,000 square foot expansion. Is the construction work exempt from Texas sales tax as an improvement for an exempt organization?

Plain-English summary

A property owner asked the Comptroller about the tax treatment of a proposed 12,000 square foot expansion to a clinic building. The building is privately owned but leased to a tax-exempt entity (referred to as "ADMINISTRATION" in the letter) until 2005, with an option to renew for another five years.

Because the exempt entity is only the tenant and not the owner, the Comptroller looked at the exemption available under Tax Code §§ 151.309 and 151.310 for improvements made for exempt organizations on property they don't own. Under that framework, an improvement to privately owned realty leased to an exempt entity can only qualify for the exemption in § 151.311 if the remaining life of the lease exceeds the anticipated life of the improvement.

Here, the lease had nine years left, extendable to fourteen years with the renewal option. The Comptroller concluded that the planned expansion — essentially new construction adding square footage to an existing building — would likely last longer than nine or even fourteen years. Since the improvement's expected life exceeds the lease term (even with the renewal), the job did not qualify for the § 151.311 exemption. The construction was treated as an improvement to realty for a private party, which is taxable.

What this means for you

Property owners leasing to exempt organizations (hospitals, clinics, governmental entities, nonprofits)

If you own a building leased to a tax-exempt tenant and plan to build out or expand the space, don't assume the exemption automatically follows the tenant's exempt status. The Comptroller applies a lease-term-versus-improvement-life test: the remaining lease term (including any renewal options actually exercised) must exceed how long the improvement is expected to last. A long-lived improvement like a building expansion will often outlast even a renewed lease, defeating the exemption.

Contractors performing improvements on leased exempt-entity space

Before treating a job as exempt because your customer is a tax-exempt organization, confirm who owns the real property. If your customer is only leasing (not owning) the building, the exemption under § 151.311 depends on comparing the lease's remaining term to the improvement's useful life — not simply on the tenant's exempt status.

Accountants and tax professionals

This letter illustrates how the Comptroller draws the line between "improving realty for an exempt entity that owns the property" (exempt under §§ 151.309/151.310) and "improving realty for a private landlord whose tenant happens to be exempt" (taxable unless the lease-term test in § 151.311 is met). Renewal options only count toward extending the lease term to the extent they push the remaining term past the improvement's anticipated life.

Common questions

Q: Is construction work on a privately owned building automatically exempt if the tenant is a tax-exempt entity?
A: No. Because the building is privately owned, the exemption depends on a separate test: the remaining life of the lease must exceed the anticipated life of the improvement.

Q: How long was the lease in this case?
A: Nine years remaining, with an option to renew for an additional five years (fourteen years total if renewed).

Q: Why didn't the expansion qualify for the exemption?
A: The planned 12,000 square foot expansion was expected to have a useful life longer than nine or even fourteen years, so the lease term (even with the renewal) did not exceed the improvement's life, as required by § 151.311.

Q: What exemption was being requested?
A: The exemption available under Tax Code §§ 151.309 and 151.310 for improving realty for entities exempt under those sections, subject to the lease-term condition in § 151.311.

Q: Can this letter be relied on for a different building or lease?
A: No. The letter states the opinion is based on the facts presented, and if there are additional or different facts, the opinion may change.

Citations and references

• Tax Code § 151.309 (exemptions for governmental entities)
• Tax Code § 151.310 (exemptions for exempt organizations)
• Tax Code § 151.311 (property used by exempt organization on leased premises — lease term must exceed improvement life)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9606L1417A07

Original ruling text

June 5, 1996

Dear **:

I have been asked to respond to your letter addressed to Tom Soto. This
contract in question is planned for the coming year.

You asked about the applicability of state sales tax to the proposed 12,000
square foot expansion to the CLINIC in CITY A, Texas. The expanded building
is privately owned and leased to the ADMINISTRATION until 2005 with an option
to renew for an additional five (5) years.

The work planned appears to be the addition of new square footage to an existing
building or new construction. Because the building is privately owned, you are
asking about the application of the exemption available to persons improving
realty for entities exempt in 151.309 or 151.310.

In order for improvements to realty performed on private property to qualify
for the aforementioned exemption, the life of the lease must exceed the life
of the improvement. The life of the lease in question is nine (9) years. A
renewed contract (a new lease) can extend the time of use for five (5) more
years to fourteen (14) years.

The planned improvement (expanding an existing building) appears to have an
anticipated life of more than nine (9) or even fourteen (14) years. The
contract is making an improvement to realty for a private party and does not
qualify for the exemption available in 151.311.

This opinion is based upon the facts presented. If there are additional or
different facts, this opinion may change.

Sincerely,

Tax Policy Division

NOTE: Previous Accession Number 9606418L