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New North Carolina Sales Tax Provisions for Contracts Related to Real Property

Some Clarity Combined With Some New Gray Area

February 21, 2017

This alert is relevant for contractors who perform construction services on real property in the state of North Carolina.  In South Carolina, contractors remain subject to the traditional sales or use tax at the time of all purchases, including building materials.  South Carolina maintains the view that the contractor is the consumer of everything he buys and he does not collect a tax on his services from the property owner. 

Last year, in an effort to increase revenue, North Carolina instituted various sales taxes on the services industry.  Now, it has been further expanded to apply to contractors who perform repair, maintenance and installation services contracts.  Real property contracts for capital improvements are explicitly exempt and remain as they have always been with no tax to be collected from the property owner.

The introduction of services taxes on certain real property improvements has been riddled with issues. But because of the overall movement toward taxes on services, the taxes are probably here to stay.  In an effort to make sense of it all, Nexsen Pruet provides the following updates:

Real Property Contracts and Defining a Capital Improvement.

When performing a real property contract for a capital improvement, the contractor is responsible only to pay the sales and use tax on all of the tangible goods incorporated into the project when purchased.  There is no additional tax collected from the landowner for any services rendered.  However, this does little to clear up when the contractor must collect taxes, without understanding who is a real property contractor and when the real property contractor performs capital improvements as opposed to repair, maintenance and installation service.

In order to qualify as a “real property contract,” improvements must be pursuant to an agreement “to perform construction, reconstruction, or remodeling with respect to a capital improvement to real property.”  In order to clarify for North Carolina contractors when they are performing a real property contract, the legislature has defined these terms:

  • New construction: The construction of or site preparation for a permanent new building, structure, or fixture on land or an increase in the square footage of an existing building, structure, or fixture on land;
  • Reconstruction: The rebuilding of a permanent building, structure, or fixture on land and which may include a change in the square footage from the prior building, structure, or fixture on land;
  • Remodeling: The process of improving or updating a permanent building, structure, or fixture on land or major portions thereof. The term includes renovation.


The terms encompass a wide swath of all owner-contractor agreements, but performance must also be “with respect to a capital improvement” for the builder to avoid the burden of collecting taxes.  The gist of it is that improvements which are merely repairs, replacements, or maintenance are distinct from capital improvements that increase the value of the real property.

A capital improvement includes any addition or alteration to real property that:

1. Becomes part of the real property, or

2. Is permanently installed or applied to the real property so that removal would cause material damage to the property or to the article itself. 

There doesn’t seem to be any bright-line rule, but if the work requires a permit, then it is most likely a capital improvement.  There is a resulting gray area of work that falls between new construction and maintaining older construction.  Replacement or installation of roofing, septic tanks, plumbing, electrical wiring, commercial refrigeration, and like improvements is likely a "capital improvement."  However, the North Carolina Department of Revenue has identified replacing damaged exterior bricks, replacing countertops, replacing a single plumbing fixture, and other work improvements one might expect to be treated as capital improvements, on its list of transactions considered repair, maintenance, and installation services for which a tax is collected from the property owner.  Other work, such as removing items from real property, painting or wallpapering, and landscaping is expressly deemed to be capital improvements. The Department of Revenue is expected to publish a more comprehensive list in the future.  

Additionally, if the property is a leasehold, the work does not qualify as a capital improvement unless the addition or alteration will vest in the owner of the building.  It does not matter if the work would otherwise appear to be a capital improvement. When it comes to leasehold improvements, it therefore is good practice to consider the sales tax effects of the agreement between the owner and the tenant.

Generally, it seems as though the legislature is still content to tax only the smaller projects for services, rather than the projects more likely to generate jobs and support this sector of the economy.


Collecting Tax on a Repair, Maintenance, and Installation Service Contract.

When fulfilling a repair, maintenance and installation services contract, the contractor purchasing the personal property that will be consumed in the project should issue Form E-595E to the retailer selling the personal property.  This allows the contractor to pass on the purchase for resale to the property owner.  The contractor should then collect the sales and use tax from the property owner on the total gross price of the contract.  In essence, the only tax collected for the project (meaning for both the items used in the project and services performed) is collected from the property owner on the total price of the contract.

However, the purchases of any tools or the like will still be taxed at the time of sale from the retailer to the contractor.  Anything that does not become part of the customer’s property should not be included in the contract taxable to the owner.

Special Mixed Transaction

Often times, a builder’s client decides to take care of “one more thing” since work is already being done.  This can cause a contractor who is clearly working on a capital improvement to perhaps also perform services that would otherwise be taxable.  Presumably understanding the nature of the business, the legislature omitted the onerous burden of collecting a tax on a small item when you entered the transaction to take on a capital improvement.  In so doing, the legislature set 10% of the contract cost as the magic demarcation line.

An example would be the contractor who is doing renovations to one side of the owner’s home, but is asked to also repair a hole in a wall in a room on the other side of the house.  If the price of the repair, maintenance, and installation services included in the project does not exceed 10% of the contract price, then it simply (for tax purposes) becomes part of the real property contract.  No tax is collected from the homeowner, but rather the sales and use tax is remitted by the contractor on purchases of any of the personal property used to repair the wall.

The contractor's responsibility to collect and remit tax becomes onerous on the contractor when the 10% threshold is exceeded. [Note: the threshold is greater than 10%; so 10% is exempt.]  In this situation, sales or use tax applies to the services portion of the contract to fix the hole in the wall.  The contractor must then allocate a price for each taxable repair, maintenance, and installation service in the contract based on a reasonable allocation of revenue that is supported by business records.  The amount of the contract that qualifies as a real property contract remains subject only to the sales tax laws applicable to a real property contract.

When the Real Property Contractor is also a Retailer.

Before the recent amendments, the definition of “real property contractor” explicitly stated it did NOT include a person engaged in retail trade.  Similarly, a “retailer” did not include a person solely operating as a real property contractor.  This reasonably led some contractors to believe that if they were in retail, then they couldn’t also qualify as a real property contractor.  But contractors were left wondering if they could perform both functions as one business. 

The new amendments make clear that a “retailer-contractor” acts as a real property contractor when it contracts to perform a real property contract, and it acts as a “retailer” when it makes a sale at retail.  The interplay can be best explained in a short example: 

If a business fabricates, sells, installs, repairs, and maintains hand railings, then the business can consider itself a retailer-contractor. 

  • Therefore, if the business is hired by a general contractor to fabricate and install a handrail as part of a new home construction or renovation, then the business must accrue and remit use tax on the purchase price of the items used to fulfill the contract and taken out of inventory, but must not collect sales tax on the amount charged to the general contractor. This should only be done if the business is provided the E-589CI by the general contractor (discussed below).
  • However, if the business is only fixing an existing handrail already attached to real property, then the business will be liable for and should charge sales tax on the total charge for the repair, maintenance, and installation service. The business does not in this case accrue and remit a sales and use tax for the items it takes out of its own inventory, but instead the cost is transferred and included as part of the gross receipts derived from the repairs subject to sales and use tax.
  • Lastly, if the business sells the handrail in retail, the business simply is liable for and should charge a sales tax on the sales price of the items sold.


Maintain Your Records – Affidavit of Capital Improvement.

Form E-589CI is a record of proof to substantiate the work was performed with respect to a capital improvement on real property, thereby not subjecting the project to a collection of the services tax.  Failure to maintain this document subjects the contractor to tax liability on the transaction.  The affidavit is filled out by the hiring party (Owner, Tenant, or Real Property Contractor) and given to the party hired to perform the capital improvement.  The Affidavit has two sections, Section I for Single Use, and Section II for Blanket Use.

Section I is applicable for a one-time use between parties.  The owner must issue Form E-589CI to the real property contractor to give notice that the project is a capital improvement.  The real property contractor must supply the Form E-589CI to any subcontractor.  The affidavit need not be provided for certain services including painting, wallpapering, or landscaping.  For larger projects, the property owner need not provide the affidavit to a general contractor who oversees the entire contract on a new construction.  A similar exception applies when the contract is to rebuild or reconstruct an existing structure.  However, the general contractor must keep records establishing that the transaction is a real property contract.

The process and paper trail is simplified when contractors use certain subcontractors exclusively for real property contracts for capital improvements.  When this is the case, the contractor can fill out Section II of the form and provide a blanket affidavit to his subcontractors for all projects.  This notifies the subcontractor it must pay sales or use tax on its materials and not pass on the collection of those taxes. However, using a subcontractor even once, to perform a repair, maintenance and installation services contract, then requires the general contractor to fill out Section I for this contractor.   

For additional information, consult Section 105-164.4H of the North Carolina General Statutes or the Department of Revenue website.

Nexsen Pruet's Construction Practice have served as attorneys for the construction industry throughout North and South Carolina for years. The group is one of the leading construction practices in the Carolinas, with experience in all areas of the industry.