When a hotel is remodeled into an apartment complex, is the remodeling contract taxed as residential or nonresidential real property work?

Subject

Hotel — Converted Into Apartment Building/Complex — Use Of Property After Conversion Determines Taxability

Plain-English summary

A taxpayer wrote to the Comptroller about a contract to convert an existing hotel into an apartment complex, asking how the remodeling work would be taxed.

The Comptroller's answer: the use of the property after the remodeling or conversion determines the taxability of the service. Here, because the remodeled hotel will become an apartment complex where people lease apartments to live in -- rather than pay for rooms to stay for 30 days or less -- the remodeling work is treated as remodeling to residential real property. If the finished complex will be mixed use, only the residential portion gets that treatment.

The letter then lays out how the tax works depending on the contract structure:

• Lump-sum contract: No tax is collected from the customer on the lump-sum price. The contractor instead pays tax on all materials, equipment, and supplies incorporated into or used in the job.
• Separated contract: Tax is collected on the agreed contract price for incorporated materials, but not on the remodeling labor. The contractor may buy the incorporated materials tax-free using a resale certificate, but must pay tax on equipment and supplies used to perform the contract.

The letter notes the opinion is based on the facts submitted and that other, similar facts could yield a different result.

What this means for you

Contractors converting hotels or other buildings into apartments

The tax treatment of your remodeling contract follows what the building will be used for once the work is done, not what it was used for before. Converting a hotel to residential apartments is treated as residential remodeling. If the finished project mixes residential and non-residential space, only the residential portion gets residential treatment -- the rest would presumably be treated as nonresidential/commercial work.

Contractors deciding between lump-sum and separated contract structures

Your contract structure changes who pays tax and on what. Under a lump-sum contract, you (the contractor) owe tax on materials, equipment, and supplies, and the customer isn't charged tax on the lump-sum price. Under a separated contract, tax is collected from the customer on the priced-out materials (which you can buy tax-free with a resale certificate), but not on labor, and you still owe tax on equipment and supplies used in the job.

Accountants and tax professionals

When advising on a change-of-use renovation (hotel to apartments or similar), the residential-vs-nonresidential classification turns on the post-conversion use of the property, per this letter. Confirm whether the finished project is fully residential or mixed use, since mixed-use projects require splitting the residential and nonresidential portions for tax purposes.

Common questions

Q: Is remodeling a hotel into an apartment complex taxed as residential or nonresidential work?
A: Residential, according to this ruling -- because after conversion, the units are leased as homes rather than rented as hotel rooms for stays of 30 days or less.

Q: What if the converted building will be used for both apartments and other purposes?
A: The letter says that if the apartment complex will be mixed use, only the portion that is residential is treated as residential remodeling.

Q: Do I charge my customer sales tax on a lump-sum residential remodeling contract?
A: No. On a lump-sum contract, no tax is collected from the customer on the lump-sum price; the contractor pays tax on all incorporated materials, equipment, and supplies used in the job.

Q: How does tax work on a separated residential remodeling contract?
A: Tax is collected on the agreed contract price for the incorporated materials (not on the remodeling labor). The contractor can buy those materials tax-free with a resale certificate but must pay tax on equipment and supplies used in the job.

Q: Could this outcome change under different facts?
A: Yes -- the letter states the opinion is based on the facts submitted, and other facts, though similar, may yield different results.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9609L1441C14

Original ruling text

September 20, 1996

Dear ***:

Thank you for your letter concerning a contract to convert an existing hotel
into an apartment complex.

The Comptroller's policy is that the use of the property after the remodeling
or conversion determines the taxability of the service. In this case, the
services are remodeling to residential real property because the remodeled
hotel will be an apartment complex in which persons will lease apartments to
live rather than pay for the use of rooms to stay for periods of 30 days or
less. If the apartment complex will be mixed use, then only the portion that is
residential will be treated as such.

If the residential remodeling contract is a lump-sum contract, no tax is
collected from the customer on the lump-sum price. The lump-sum contractor is
responsible for paying tax on all incorporated materials, equipment and
supplies used in performance of the contract.

If the residential remodeling contract is a separated contract, tax is
collected on the agreed contract price for incorporated materials, but not the
remodeling labor. The separated contractor may purchase the incorporated
materials tax free by giving a resale certificate. The contractor must pay tax
on equipment and supplies used in performance of the contract.

This opinion is based on the facts you submitted. Other facts, though similar,
may yield different results.

You may call me toll free at 1-800-531-5441, ext. 5-0030. The direct line is
512/475-0030. You may also write to Tax Policy, Comptroller of Public Accounts.

Sincerely,

David Somerville
Tax Policy Division

NOTE: Previous Accession Number 9609793L