Construction Contracts: Mind Your Language!

Word for word. When undertaking capital improvements, boards should always review the language in their construction contracts. But special attention must be paid to two terms in particular: “restoration” and “repair.” Using the wrong one could cost you when it comes to state sales tax.

The rules. New York State does not collect sales tax from building owners who make capital improvements that add value and prolong the life of their property. With repairs and maintenance work, however, owners are subject to taxes for both materials and labor. “We’ve had several buildings where contractors incorrectly described projects as repairs when they were actually restorations,” says Robert Mellina, a partner at the accounting firm Prisand, Mellina, Unterlack & Co. “If the building or the contractor gets audited by the state, that’s when you run into trouble, because you’re going to have to pay up.”

That’s precisely what happened at a 25-story co-op in midtown Manhattan that spent $1.1 million for an extensive restoration of two sides of the building’s facade. “The board wasn’t aware of the contractor’s mistake until we caught it while doing the co-op’s annual financial audit,” Mellina says. “Then the building got hit with a random audit by the state, which looked at the invoices and said the co-op owed $100,000 in sales tax.” After bringing in the project’s engineer to explain the exact scope of the work and why it qualified as a capital improvement, the board ended up settling for half that amount. “You can only fight so long, because hiring a tax attorney and going to court to appeal gets very expensive,” Mellina says. “At some point you just throw up your hands and move on.”

The takeaway. The co-op has since learned its lesson. “Before entering into any capital construction contract, boards should check with their accountant, who can determine whether the work qualifies as a capital improvement and exempts them from sales tax,” Melina says.

The Department of Taxation and Finance’s Publication 862, Sales and Use Tax Classifications of Capital Improvements and Repairs to Real Property, which is available at http://bit.ly/SalesTaxList, lists what types of jobs are considered capital improvements as opposed to taxable repairs. 

“If the project does qualify, have your professionals go over the contract to be sure it uses the word ‘restoration’ rather than ‘repair,’ ” Melina says. “Otherwise you’re shooting yourself in the foot.”