Psst. Did you hear the one about the co-op that got audited for not paying sales tax on building repairs and wound up paying thousands of dollars in interests and fines?
Sounds like the beginning of a bad joke, doesn't it? But CPA Carole Newman, a principal in Newman, Newman & Kaufman of Syosset, isn't laughing. That's because she's been called in to play the point person more and more frequently for co-ops and condos suffering through the agonies of an audit whose owners don't understand why the state is picking on them.
"I think this has been an issue for a long time, but it hasn't been recognized as an issue until recently, as the result of more New York State sales tax audits being performed by the New York State Department of Taxation and Finance," observes Newman.
It's a fairly typical trap into which co-ops and condos fall, she explains, because many management firms and/or boards don't understand what their responsibilities are when it comes to paying vendors for work being done in the building. In short, when is an improvement a capital improvement and when is an improvement just a repair?
For the record, when a co-op or condo contracts for a capital improvement, it is not responsible for paying sales tax on the work if it fills out a "Certificate of Capital Improvement" and gives it to the vendor. However, if the contractor performs a job that is a repair, as defined by the state, sales tax must be collected from the customer unless the building falls under a specific state exemption.
Where buildings trip up, notes Newman, is in assuming that what they call a capital improvement is a state-approved capital improvement. And filling out a Certificate of Capital Improvement does not clear the building from having to pay a sales tax. If the state deems the work a repair, the building has to pay the tax. And if it doesn't pay it to the vendor, it has to pay it to the state.
"I think the issue is with management companies," Newman notes. "They are not apprised of the issue or they are not necessarily advising their clients that they should be paying sales tax on repairs that they do."
Or, as Richard Montanye, a CPA with Marin & Montanye in Long Island, puts it: "What you call something has nothing to do with whether or not it's taxable by the state. You can do a million dollars worth of waterproofing on a building, and, because of its size, call the work a capital improvement. But that's an item that is taxable under New York State [law]. It's not necessarily black and white. Each item is different and components of a particular job can be different."
So the whole situation begs the question: what is a capital improvement, and what exactly is a repair? For an answer, managing agents and boards should contact the New York State Department of Taxation and Finance and ask for Publication 862: Sales and Use Tax Classifications of Capital Improvements and Repairs to Real Property. (For business tax information: 800-972-1233; for general information: 800-225-5829; for forms and publications: 800-462-8100. Internet access: www.tax.state.ny.us) The 27-page publication lays out the definition of a capital improvement and a repair, and lists the forms required by co-ops and condos and vendors if they are looking for sales tax exemption.
According to the publication, a capital improvement is an addition or alteration to real property that:
- 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 so permanently affixed to the real property so that removal would cause material damage to the property or article itself; and
- is intended to become a permanent installation.
- In the case of a capital improvement, if you are a property owner who:
- purchases materials and supplies only and you perform your own labor, you pay the tax to the supplier on the materials and supplies;
- purchases materials and supplies and hires a contractor to perform the labor, you pay tax to the supplier on the materials and supplies, but you do not pay tax on to the contractor for the labor;
- purchases materials and supplies and labor from the contractor, you pay no tax.
Under the definition of repair and maintenance supplied by the state, "repair and maintenance relates to keeping real property in a condition of fitness, efficiency, readiness and/or safety or to restore it to such condition."
The publication goes on to expound on what happens to the sales tax. In the case of a job that constitutes repair or maintenance:
- if you are a property owner who purchases materials and supplies only and perform your own labor, you pay tax to the supplier on the materials and supplies;
- if you are a property owner who purchases materials and supplies and hires a contractor to perform the labor, you pay tax to the supplier on the materials and supplies and to the contractor for the labor;
- if you are a property owner who purchases materials and supplies and labor from a contractor, you pay tax to the contractor on the total charge.
Okay, so what exactly is a capital improvement, in terms that managing agents and co-op and condo boards can understand? The publication provides a list of capital improvements and repairs, running from A for air conditioning to W for windows.
For example, if a co-op needs extensive brick work, the job is a capital improvement, according to the state publication, if there is "construction of new or complete replacement of brick: chimneys, exterior, surfaces, fireplaces, stairs or steps, structures or walls."
The work falls under a repair, if the co-ops or condo is "fixing cracks, replacing damaged bricks, repointing, or sandblasting." For another example, installing or completely replacing an electric furnace or gas furnace falls under the capital improvement column, but cleaning and replacing parts of the furnaces does not.
"Plumbing heating, painting, electrical, plastering, these are all repairs that are sales-taxable, but very often management is paying bills without paying sales tax. We see these audits happening and the penalties for not paying the tax can be significant, and the interest that accrues from the time the work was performed to the time the audit takes place is significant," warns Newman.
"We recently had a co-op undergo an audit and they had to pay $90,000 for unpaid sales tax and interest," she adds. "And most of the work that was found in the audit was exterior restoration work." The property, a large co-op with five different buildings, made the costly mistake of not understanding its responsibilities.
There are gray areas, acknowledge the experts, who say that managing agents should contact an accountant before any extensive work is performed. According to Newman, one building in lower Manhattan that instituted millions of dollars of restoration on its building exterior successfully fought the fines imposed by the state. But such success is rare.
"I would say that if a co-op were undergoing that kind of extensive work, they should have their accountant advise them," maintains Newman. Newman and Montanye both speculate that the number of audits is probably increasing for two reasons. First, the state is auditing vendors and contractors and scrutinizing the buildings for which they did work. Second, like any agency, the Department of Taxation and Finance picks certain industries at certain times to scrutinize.
"It seems to come in waves," says Montanye, although there seems to be more activity of late. If co-op and condo boards want to avoid getting into trouble, he has some simple advice: "Consult an accountant on whether sales tax should be paid."