New York Sales and Use Tax: A Hidden and Costly Pitfall
A real estate business faces a myriad of sales tax issues on a daily basis and many are not aware of the legal obligations and the resulting tax consequences.
November 12, 2007
Sponsored by The Schonbraun McCann Group
by James E. Helmus
Originally published in the October 2007 issue of Real Estate New York.
It’s a simple fact that many real estate businesses face a lurking and very costly issue: the New York sales and use tax. The primary reason for this is that fundamentally one does not think of sales tax when viewing a real estate business, other than an add-on cost of purchasing items used in the business such as equipment, fixtures and supplies. The fact is, a real estate business faces a myriad of sales tax issues on a daily basis and many are not aware of the legal obligations and the resulting tax consequences.
Unfortunately, the reality of such consequences usually hits when a notice of examination is received from the New York State Tax Department. Such examinations often involve an audit of transactions and purchases made by a real estate business of up to a six-year period prior to an audit. This can be particularly troublesome if a real estate asset under audit was sold during the examination period, and the relevant records are either stored away, transferred to the new owner, or simply unavailable. Those who have experienced such an examination know very well the significant tax assessment that can result, often in the range of hundreds of thousands of dollars, and even in the millions.
The problems are numerous. The first is that many real businesses are required to register as a vendor for New York sales and use tax purposes. This is because they enter the sales tax collection arena due to certain tenant charges, including sub-metered electricity, photo-id cards, cleaning charges, security and rubbish removal. A landlord’s failure to collect and remit any required sales tax related to such charges could result in the landlord paying over the tax to the state upon audit. The landlord may not be able to ultimately recover the tax, particularly if the applicable tenant(s) vacated the premises prior to the audit.
This problem is further exacerbated by the landlord failing to register and file required sales tax returns, since this could result in a minimum six-year audit period as opposed to a limited three-year period had the returns been properly filed.
Real estate owners also must deal with a use tax issue. For example, taxable purchases made by a New York real estate business from an out-of-state vendor not required to collect New York sales tax results in the imposition of use tax, which by law requires a purchaser to regularly self-assess and pay such tax (which is the same rate as the sales tax) over to New York State. Supplies, fixtures and equipment are examples of recurring purchases often made from out-of-state vendors upon which sales tax is commonly not charged.
But, by far, the single most common use tax problem area pertains to the issue of capital improvements vs. repairs. Most know that a qualified capital improvement is not subject to sales or use tax, while a repair is taxable. But, few understand what constitutes a capital improvement versus a repair in the eyes of the State. New York tax examiners take a very aggressive stance on this issue and routinely assess considerable use tax in reclassifying projects that they deem to be repairs that were treated as capital improvements by a taxpayer and the associated contractor. The fact that a capital improvement certificate was properly completed between a taxpayer and a contractor is of little meaning to an examiner that deems the project a taxable repair.
A final point is the issue of successor liability for New York sales and use tax purposes in the case of the purchaser of a real estate business. New York has a technical requirement that a purchaser of any business within the state is obligated to report the proposed transaction at least ten days prior to taking possession of the business. Failure to do so can result in the purchaser inheriting any unpaid New York sales or use tax liabilities of the seller. This is the case regardless of whether the purchaser acquires an entity interest or the outright assets of the seller, and thus should be considered an important part of the overall acquisition due diligence process.
The message here is simple: a focus on sales and use tax today can avoid a costly headache tomorrow. In the real estate world, with assets continually changing hands and investors coming and going, no one wants to get stuck with an unexpected liability down the road, especially someone else’s. A capital call is never a good thing …
James E. Helmus is a partner and leads the State and Local Tax Services Practice for The Schonbraun McCann Group (www.smgllp.com) in New York. The Schonbraun McCann Group is a national real estate and finance consulting firm. Contact Helmus at firstname.lastname@example.org.
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