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How North Carolina Sales & Use Tax Works for Real Property Contracts and Related Services

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Sales tax on real property construction and related services is notoriously complex because of the likely mix of taxable and nontaxable transactions in your work. Your potential for operating as both a consumer and retailer for North Carolina sales tax purposes can add another layer to your compliance obligations. In this guide, we explain the different transaction scenarios real property contractors will likely encounter and how North Carolina sales tax may apply to them. Our sales tax professionals frequently see audits and assessments against real property contractors and work to defend their interests in related administrative proceedings and appeal processes with the North Carolina Department of Revenue.

The Different Types of Contractor Transactions and Their Sales Tax Treatment

1. Real Property Contracts for Capital Improvements

North Carolina does not impose sales tax on the gross receipts from a real property contract to perform a capital improvement as explained in SUTB 72. However, contractors are the consumers of tangible personal property and certain digital property and are generally responsible for paying sales tax at the time of purchase or use tax when materials are incorporated into a real property contract. See § 105-164.4H.

The North Carolina Department of Revenue defines capital improvements as the following types of projects:

  • New construction, reconstruction, or remodeling
  • Installation of a service provider’s network asset (e.g., telecommunications, water, gas, electric)
  • Installation of certain fixtures and equipment, such as those that are capitalized and depreciated under GAAP or IFRS
  • Painting and wallpapering
  • Replacement or installation of septic systems, siding, roofing, plumbing, electrical, and other similar systems
  • HVAC replacement or installation
  • Replacement or installation of roads, parking lots, sidewalks, driveways, and decks
  • Services performed to fix an issue under a real property contract if performed within 6 months of completion (or 12 months for new construction)
  • Landscaping projects
  • Other permanently affixed additions and alterations to real property that are not considered “repair, maintenance, and installation services”

Service providers who perform capital improvements under a real property contract are responsible for collecting a completed affidavit Form E-589CI from the owner, tenant, or general contractor they are working for. Aside from cases of fraud and other egregious uses, this form can protect contractors from liability for sales tax on gross receipts for transactions that were improperly classified as a capital improvement. However, failing to substantiate capital improvements with Form E-588CI can impose joint and several liability on the contractor and their customer for the sales and use tax owed on the incorporated materials. See Important Notice: Updated Form E-689CI, Affidavit of Capital Improvement (March 6, 2018).

2. Repair, Maintenance, and Installation Services

Real property projects that do not qualify as a capital improvement are likely taxable as a repair, maintenance, or installation service as defined in G.S. 105-164.3(225). Contractors are generally retailers in these transactions and must collect sales tax from their customers for labor and any transferred tangible personal property. See G.S. 105-164.4(a)(16). However, contractors can purchase the transferred personal property using a resale certificate.

Activities that commonly qualify as repair, maintenance, and installation services include the following:

  • Services to keep property in a working condition and to avoid breakdown or deterioration. For example, cleaning, washing, or polishing property.
  • Services to restore, calibrate, or refinish property into a working order.
  • Diagnostic and other troubleshooting services to determine problems that would need to be addressed to restore the property to a good condition.
  • Services to inspect and monitor property.
  • Services to install and set personal property that does not qualify as a capital improvement. For example, installing carpet, flooring, windows, doors, cabinets, countertops.

3. Mixed Transaction Contracts – The 25 Percent Rule

A North Carolina contractor’s projects may involve both real property contracts and taxable repair, maintenance, and installation services that are unrelated to the capital improvement. These are known as mixed transaction contracts under G.S. 105-164.3(137) and the taxability depends on the application of the 25 percent rule.

If repair, maintenance, and installation services are less than or equal to 25 percent of the sales price, then they are taxable as a real property contract. In other words, the contractor does not need to collect sales tax from the customer but must pay sales or use tax on purchased materials for the project. Alternatively, if the repair, maintenance, and installation services are greater than 25 percent, the contractor must collect sales tax on the gross receipts from the customer for that allocated amount. See G.S. 105-164.4H(d). The contractor treats the remainder of the gross receipts related to the capital improvement portion as a real property contract.

The Main Sales and Use Tax Concerns for Real Property Contractors in North Carolina

Differentiating Capital Improvements from Other Taxable Services

The greatest challenge for real property contractors is properly classifying their work as either capital improvements or taxable repair, maintenance, and installation services. The North Carolina Department of Revenue provides additional guidance on Section 72-21 of SUTB 72 to help contractors determine the nature of their services for sales tax purposes, which can be useful in knowing whether you are the consumer, retailer, or both under a transaction. For example, the chart explains that the replacement of a chimney is an exempt capital improvement while the addition of a flue or liner is a taxable installation service.

Erroneous Collections Under a Real Property Contract

The common consequence of misclassifying your contracting services in North Carolina is an erroneous collection of sales tax for capital improvements under a real property contract. North Carolina expressly prohibits contractors from separately stating amounts collected for sales tax in their real property contracts and requires contractors to remit these amounts to the Department of Revenue. See G.S. 105-164.4H(c). An audit can quickly reveal contracts where sales tax was erroneously collected, creating huge tax liabilities for contractors. You may face additional penalties and interest charges for erroneously collected amounts.

Sourcing Taxable Property and Services as a Contractor

The location of your customer’s capital improvements and other contractor services can influence the amount of sales and use tax owed because of county rates that apply in addition to the state’s 4.75 percent rate. For example, the total sales tax rate is highest in Durham and Orange counties at 7.5 percent while other counties, such as Richmond have a lower 6.75 percent rate.

North Carolina sources the sales and use tax rate to the location where the purchaser takes possession or first uses the property. See SUTB 4. As a result, contractors may owe additional use tax on materials transferred as part of a capital improvement in a location that has a higher county rate. For example, materials purchased in Hertford but transferred to a customer in Durham may result in use tax liability because of the half-percent difference in county rates.

Get Help from a Sales Tax Professional Today

Our sales tax professionals regularly help real property contractors across the country with the many sales and use tax challenges they face because of their industry. We understand Department of Revenue guidance is not always clear and does not always explain the precise nature of your work as a contractor, whether it’s a capital improvement or taxable service. If you recently received a notice about an audit or assessment from the North Carolina Department of Revenue, you can schedule a consultation with our team about audit defense and appeal services.

Contact us today for help involving North Carolina sales tax for real property contracts.

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