Affordable housing—Sales and use tax complications

Builders trying to keep costs—and home prices—down should consider these tax issues before breaking ground
How a contractor bills can impact taxability. (Photo: Dragonimages, Dreamstime.com)

As municipalities seek to encourage and incentivize developers to build affordable housing, there is an important but often missed issue for consideration. Sales and use tax compliance for contractors is especially difficult in Colorado. Colorado’s 70-plus home rule cities can and often do differ from the Colorado Department of Revenue and from each other on sales tax issues.

When construction is involved, the complications dramatically increase. Knowing the city-specific requirements, and the sales and use tax rates and ramifications, will help ensure a successful and profitable project without an unanticipated future audit assessment for any of the parties to the contract and their subs or suppliers.

One of the principal difficulties involves “lump sum” versus “time and material” billing. In fulfilling agreements, contractors often provide true construction services as well as items such as appliances or other services or items that are not considered improvements to real property. The underlying question is, “Are you acting as a contractor or as a retailer?” How a contractor bills can impact taxability. Selecting the proper billing method is vital to ensure the intended tax treatment.

[Related: 4 sales tax traps for Colorado businesses]

City-specific municipal tax code and interpretations may even dictate required billing methods. Problems arise if the services are provided under a lump-sum agreement or on an invoice that a city determines is the sale of goods with installation, rather than construction. The otherwise nontaxable labor portion of the job becomes part of a mixed transaction, and the entire amount is generally treated as taxable.

Contractors are often considered the end user of the materials they purchase and thus must pay sales tax on the materials purchased, or use tax if sales tax wasn’t charged or if the building permits require a use tax deposit. When a use tax deposit is involved, the general contractor must provide copies to subcontractors and suppliers so the local city and perhaps county tax covered under the permit is not paid again. Permits don’t cover the state-collected local jurisdictions or special districts’ sales tax, so contractors generally will have paid a combination of sales tax and use tax on the same purchase up to the total combined sales tax rate.

[Related: Builders, embrace change to increase profitability]

A common problem occurs when the contractor’s customer is an exempt non-profit, charitable or even government entity such as the City and County of Denver itself. Though the state may exempt such, the exemption does not pass through for all home rule cities. Subsequent audits result in an assessment for the unpaid tax, interest and penalties.

These are just a few of the common issues and pitfalls to be considered when doing construction work in the various local jurisdictions in Colorado. Properly understanding the state’s requirements, plus county- and city-specific requirements, prior to choosing a development site or bidding on a project will bode well for all parties involved.

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