Is replacing a temporary fire sprinkler system with a new one during finish-out of a never-occupied strip-center lease space taxed as new construction or as nonresidential remodeling?

Subject

Fire Sprinkler System — New System Installed In Finished Out Space To Replace Temporary System Installed To Protect Property During Construction Or While Lease Space Was Empty

Plain-English summary

A taxpayer finishing out a lease space in an existing strip center asked the Comptroller whether that work was "new construction" or "nonresidential remodeling" for sales tax purposes. The lease space had a temporary fire sprinkler system installed when the strip center was originally built, meant to protect the space while it sat empty and unoccupied. The space was now being finished out for its first tenant, and the taxpayer's company was either removing the temporary sprinkler system and installing a new one, or simply installing the new system outright.

The outcome is mixed, not a flat taxable-or-exempt answer. The classification turns on whether the space had already been finished out and made ready for occupancy, or whether it was only "roughed-in" with the finish-out work now happening for the first time. Since this lease space had never been occupied and was only roughed-in, the Comptroller ruled that installing the new fire sprinkler system is new construction -- and that conclusion doesn't change just because a temporary sprinkler system happened to already be in place during construction or while the space sat vacant.

Once the work is classified as new construction, the tax result is clear: labor is not taxable, but materials are taxable. Who actually pays the tax on the materials then depends on the type of contract used -- a lump-sum contract versus a separated contract.

What this means for you

Landlords and developers finishing out never-occupied lease spaces

If your space was only roughed-in (i.e., it never had floor coverings, wall coverings, or other finish-out items installed) and you're now doing that finish-out work for the first tenant, the work qualifies as new construction -- even if a temporary fire protection system was already installed to protect the property in the meantime. Under new construction, labor charges are not taxable, but the materials used are taxable.

Landlords and developers modifying already-finished spaces

The ruling draws a contrast: if the finish-out was already completed and the space was ready for occupancy (the example given is a shopping complex fully finished by the developer, where a prospective tenant then wants a different paint color before moving in), that additional work is remodeling, not new construction -- even though the space was never actually occupied.

Contractors installing fire sprinkler systems in finish-out projects

Structure your contract carefully. Because materials are taxable in a new-construction fire sprinkler installation, whether you (the contractor) or your customer bears responsibility for that tax depends on whether you use a lump-sum contract or a separated contract.

Common questions

Q: Is installing a new fire sprinkler system in a lease space that's never been occupied taxed as new construction or remodeling?
A: New construction, as long as the space was only roughed-in and this is the first time it's being finished out.

Q: Does it matter that a temporary fire sprinkler system was already protecting the space during construction?
A: No. The letter is explicit that the presence of a temporary system installed to protect the property during construction, or while the lease space sat empty, does not turn the later installation of the new system into remodeling.

Q: Is the labor to install the new fire sprinkler system taxable?
A: No -- for work classified as new construction, the labor is not taxable.

Q: Are the materials used to install the new fire sprinkler system taxable?
A: Yes, the materials are taxable.

Q: Who pays the tax on the materials -- the contractor or the customer?
A: It depends on the contract type: a lump-sum contract versus a separated contract controls who must pay the tax on the materials.

Q: What if the finish-out work happens after the space was already fully finished and ready for occupancy?
A: That later work is remodeling, not new construction, even if the space was never actually occupied by a tenant.

Citations and references

The original ruling does not cite any specific statute or administrative rule by number; it addresses only the general new-construction-versus-remodeling distinction under Texas sales tax law.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9701897L

Original ruling text

January 10, 1997

Dear ***:

I am responding to your question regarding the finish out of a lease space
in an existing strip center. Presumably, your company is removing the
temporary fire sprinkler system and installing the new one or simply installing
the new fire sprinkler system.

You explained that an existing strip center has a lease space that has never
been occupied. When it was originally built a temporary fire sprinkler system
was included that protected the lease space. This space is currently being
finished out for its first tenant. You asked whether the work is considered
new construction or nonresidential remodeling.

The determination between new construction or remodeling will turn on whether
the lease space was finished-out and ready for occupancy or whether it was
only roughed-in and the finish-out occurs in preparation for the first occupant.
If the space was only roughed-in and the finish-out includes adding the floor
and wall coverings, etc., for the first time, the work is new construction.

However, any finish out work performed after initial finish out has been done
is remodeling even though the improvement has not been occupied. An example
would be a shopping complex completely finished by the developer prior to
renting to tenants. A prospective tenant wants a different color scheme
before taking possession. The repainting by the developer is remodeling.

The installation of the new fire sprinkler system in an area that has only been
roughed-in is new construction. (The fact that a temporary fire system was in
place to protect the property during construction or during the time the lease
space was empty does not change this to remodeling.) The labor is not taxable,
but the materials are. The type of contract (lump-sum vs. separated) will
control who must pay the tax on the materials.

This opinion is based upon the facts presented. If there are different or
additional facts, this opinion may change. You may also write to Tax Policy
Division, Comptroller of Public Accounts.

Sincerely,

Tax Policy Division