Capital Improvement vs Repair: What the New York Construction Industry Needs to Know

Contactors generally perform two types of transactions for sales tax purposes in New York; (1) performance of a capital improvement to real property, or (2) repair and other maintenance services to real property. As simple as it may sound, distinguishing whether a particular project qualifies as a capital improvement and therefore tax exempt, can be quite problematic and potentially significant in terms of tax dollar savings if a project is incorrectly evaluated.

How to Define Capital Improvement Projects

New York utilizes a three-prong test to define a capital improvement. A project will qualify as a capital improvement if it meets all three of the following:

• Substantially adds to the value of the real property, or appreciably prolongs the useful life of the real property;
• Becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property of the item itself, and
• It’s intended to become a permanent installation.

Projects that meet the above criteria are not subject to New York sales tax to the owner. On these projects, the contractor must obtain a properly completed Certificate of Capital Improvement, Form ST-124 from the owner. Once obtained, the contractor will pay sales tax on the purchases of the materials for the project. The use of subcontractors will follow the same principle.  No tax is due on labor charges for the use of subcontractors in a capital improvement project. Subcontractors are required to pay tax on their purchases of materials. Sales tax on the purchases by the contractors are normally passed on to the owner in the total invoice, but the invoice itself is not subject to sales tax.

Note however, the addition of a mobile home to real property is never a capital improvement, regardless of how it is installed. New York also implements special rules in regards to floor coverings. That is, the installation of carpet, padding, linoleum, vinyl roll floor, and other similar floor covering only qualifies as a capital improvement if it’s performed as the initial floor covering. If the floor covering installation is performed in an existing building, or in a building more than six months after the building has been completed, the floor covering and installation charges are deemed as a repair/maintenance and subject to New York sales tax.

How to Define Repair and Installation Projects

If the project is a repair, the contractor must pay sales tax on all the materials purchased for the job. In addition, sales tax is due from the owner based on the contractor’s total invoice for the labor and materials of the job. The contractor may in turn claim a credit on their sales and use tax return for the sales tax paid on the materials that were purchased since sales tax is charged to the owner on the same materials.

To illustrate differences between a capital improvement and a repair/maintenance, below are a few comparisons of work that could be performed:

Due to the difference in tax consequence between a capital improvement and repair/maintenance project, it’s imperative for the contractor to make correct determination prior to beginning the project. The contractor must know whether or not to include sales tax on the cost of materials incorporated into the project. If a contractor is performing a combination of a capital improvement and repair/maintenance work, they should separately state the invoice for these jobs, and only charge sales tax on the repair/maintenance work performed.