Cecily Zamora
North Carolina's tax laws on capital improvements are complex, and the state levies sales and use taxes on certain transactions. A capital improvement is defined as new construction, reconstruction, or remodelling, as well as work requiring a permit under the State Building Code, excluding repairs or replacements of individual items. Real property contracts for capital improvements are non-taxable, but contractors are responsible for paying sales tax on materials. The location of the customer impacts the tax rate, with Durham and Orange counties having the highest rate at 7.5%. Contractors must properly classify their work to avoid misclassifying their services and erroneously collecting sales tax for capital improvements.
| Characteristics | Values |
|---|---|
| Definition | A contract between a real property contractor and another person to perform a capital improvement to real property |
| Examples | New construction, reconstruction, or remodelling; Installation of a service provider's network asset; Installation of certain fixtures and equipment; Replacement of a chimney |
| Tax treatment | North Carolina does not impose sales tax on the gross receipts from a real property contract to perform a capital improvement |
| Forms | Form E-589CI, Affidavit of Capital Improvement; Form E-589P, Affidavit of Tax Paid by Real Property Contractor |
| Other | The location of the customer's capital improvements can influence the amount of sales and use tax owed due to county rates |
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What You'll Learn
New construction, reconstruction, or remodelling
In North Carolina, a real property contract is defined as a contract between a real property contractor and another person to perform a capital improvement to real property. A transaction must meet the definition of a "capital improvement" to qualify as a real property contract.
For example, the replacement of a chimney is considered an exempt capital improvement, while the addition of a flue or liner is considered a taxable installation service. Similarly, services to install and set personal property, such as carpets, flooring, windows, doors, cabinets, and countertops, do not qualify as capital improvements.
On the other hand, projects that involve the installation of certain fixtures and equipment, such as telecommunication, water, gas, and electric network assets, can be considered capital improvements. This also includes the replacement or installation of septic systems, siding, roofing, plumbing, electrical systems, and other similar systems.
It is important for real property contractors to properly classify their work as either capital improvements or taxable repair, maintenance, and installation services to avoid erroneous tax collection.
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Installation of fixtures and equipment
In North Carolina, the installation of fixtures and equipment is considered a capital improvement for tax purposes if it meets specific criteria. Firstly, the installation must be attached to real property, meaning it becomes part of the property and cannot be easily removed. This can include fixtures such as telecommunications, water, gas, and electric systems.
Secondly, for an installation to qualify as a capital improvement, it typically needs to be capitalized and depreciated under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). This means that the value of the installed fixture or equipment is spread out over a period of time, rather than being expensed all at once.
Additionally, installations that are depreciated under the Internal Revenue Code or expensed under Section 179 of the Internal Revenue Code may also qualify as capital improvements. Examples of such installations include septic tank systems, siding, roofing, plumbing, electrical systems, and commercial refrigeration.
It's important to note that repair, replacement, or installation of individual items such as electrical or plumbing components, water heaters, gutters, or similar items that are not part of new construction, reconstruction, or remodelling are generally not considered capital improvements.
The distinction between capital improvements and taxable repair, maintenance, and installation services is crucial for contractors in North Carolina. Misclassifying these services can lead to errors in collecting sales tax for capital improvements under a real property contract. To assist with this, the North Carolina Department of Revenue provides guidance to help contractors determine the nature of their services for tax purposes.
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Replacement of systems
In North Carolina, the replacement of certain systems is considered a capital improvement for tax purposes. The North Carolina Department of Revenue defines capital improvements as projects that involve the replacement or installation of specific systems, such as septic systems, siding, roofing, plumbing, electrical, and other similar setups.
It is important to note that the replacement or installation of individual items or components within these systems may not always qualify as capital improvements. For example, the repair or replacement of electrical components, gas logs, water heaters, or similar items is typically excluded from this category if they are not part of new construction, reconstruction, or remodelling.
On the other hand, the replacement of a chimney, for instance, is considered an exempt capital improvement, while adding a flue or liner is classified as a taxable installation service. This distinction highlights the importance of properly classifying contracting services to avoid errors in collecting sales tax for capital improvements.
The following are some specific examples of system replacements that would qualify as capital improvements in North Carolina:
- Septic tank system
- Siding
- Roof
- Plumbing
- Electrical
- Commercial refrigeration
- Irrigation or sprinkler system
- Heating or air conditioning unit
- Ventilation system
These replacements are typically considered capital improvements when they are part of new construction, reconstruction, or remodelling projects, and they are not considered routine repairs or maintenance.
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Repair, maintenance, and installation services
In North Carolina, "repair, maintenance, and installation services" (RMI services) are taxable unless state law specifically exempts the type of service performed from tax. RMI services are performed on tangible personal property, motor vehicles, certain digital property, and real property.
RMI services include activities such as floor refinishing, installation of flooring, windows, doors, cabinets, countertops, and other installations where the item being installed may replace a similar existing item. The term also includes activities to keep property or a motor vehicle in working order to avoid breakdown and prevent deterioration or repairs.
RMI services are distinct from "real property contracts," which are non-taxable contracts between a real property contractor and another person (e.g., a local government) to perform a capital improvement to real property. A capital improvement can include new construction, reconstruction, or remodeling, as well as the installation of certain fixtures and equipment.
When a contractor performs a capital improvement for a local government, they must pay applicable state and local sales taxes on the materials they purchase. However, they do not need to collect state or local sales taxes from the local government for the service itself.
It is important for real property contractors to properly classify their work as either capital improvements or RMI services to ensure correct taxation. Misclassification can result in the erroneous collection of sales tax for capital improvements under a real property contract, which is prohibited in North Carolina.
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Real property contracts
In North Carolina, a real property contract refers to a contract between a real property contractor and another party for the purpose of performing a capital improvement to real property.
A capital improvement is defined as an addition or alteration to real property that involves new construction, reconstruction, or remodeling of a building, structure, or fixture on land. This includes projects such as the installation of a service provider's network assets (e.g. telecommunications, water, gas, electric), certain fixtures and equipment, and the replacement or installation of septic systems, siding, roofing, plumbing, electrical, and other similar systems.
For real property contractors, it is important to properly classify their work as either capital improvements or taxable repair, maintenance, and installation services. This classification determines whether the contractor or the customer is responsible for paying the sales or use tax. In North Carolina, contractors are generally responsible for paying sales tax on materials used in a real property contract, while the customer may be responsible for sales tax on taxable repair, maintenance, and installation services if they exceed 25% of the sales price.
To substantiate a real property contract, Form E-589CI, Affidavit of Capital Improvement, is generally required. Additionally, Form E-589P, Affidavit of Tax Paid by Real Property Contractor, certifies that the contractor has paid the sales and use tax due on all items used in the contract. These forms should be provided to the owner, tenant/lessee, and/or general contractor involved in the real property contract.
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Frequently asked questions
Capital improvements are projects that involve new construction, reconstruction, or remodeling. It also includes work that requires a permit under the State Building Code, excluding repairs or replacements of individual items.
A real property contract is an agreement between a real property contractor and another party to perform a capital improvement to real property.
Generally, Form E-589CI, Affidavit of Capital Improvement, must be issued and kept on file for a real property contract. If you receive this form within 90 days of the sale or 120 days of a substantiation request, the transaction is considered a capital improvement.
Yes, the location of the capital improvement can impact the sales and use tax owed due to varying county rates. For example, Durham and Orange counties have a higher total sales tax rate of 7.5% compared to Richmond County, which has a rate of 6.75%.
