Capital Improvements
Capital improvements typically offer the most savings when a project is labor-intensive but has minimal wholesale costs, such as painting a house or installing kitchen cabinets. In our industry, however, savings are minimal because of the minimal markups and minimal labor.
What Qualifies as a Capital Improvement?
To qualify as a capital improvement, the project must meet the following criteria:
- It significantly adds value to the property or extends its useful life.
- It becomes a permanent part of the property, with removal causing material damage.
- It is intended as a permanent installation.
Sales Tax on Capital vs. Non-Capital Improvement Projects
Many people have a false understanding that in a capital improvement project there is no sales tax paid. However, sales tax is always collected by state; it just differs in the amount, how it’s calculated, and how it’s collected. In capital improvement projects, the contractor pays sales tax on the materials when purchasing them from their wholesale source. For non-capital improvement projects, the contractor does not pay sales tax when purchasing but instead collects sales tax on the final sale to the customer.
When Capital Improvement Claims Make Sense
When doing a project like having your house painted, the contractor pays sales tax when purchasing the materials from their supplier (e.g., $86.25 of tax on $1,000 of paint). Then they add labor and a markup, bringing the total project cost to $21,086.25. If this wasn’t treated as a capital improvement, sales tax would be calculated on the total project of $21,000.00 (reduced by the material tax as it’s not part of the contractors cost), adding $1811.25 in tax and in turn bringing your total cost to $22,811.25. The savings of a capital improvement in a project with low material costs is substantial.
Minimal Savings on Propane Installations
Propane installations, in contrast, the total cost of the project is mainly based on products with minimal labor, and our overall markup is minimal as we don’t look to profit on installations.
For example, on a non-capital improvement project, the total product wholesale cost from our vendor might be $3,000.00. Since we buy products as a reseller, we don’t pay tax upfront but have to collect it on the total sale price from the end user. Add in our minimal labor and small markup it brings the pre-tax total to $3,500.00, add in sales tax and the total quoted price is $3,801.88.
If the same project is treated as a capital improvement, we would pay sales tax upfront on the $3,000 product wholesale cost, increasing our cost to $3,258.75. After adding in the same markup, your total cost with the capital improvement applied would be $3,758.75.
As you can see the savings is minimal savings of only $43.13.
Why We Don’t Default to Capital Improvements
We handle a variety of transactions, most of which don’t qualify as capital improvements. In capital improvement cases, we must calculate the total product cost and pay sales tax when filing state returns. Switching to a capital improvement model would require tracking all purchases and filing for tax credits on non-capital improvement projects, which is time-consuming and complex, especially given the small savings.
Given the minimal financial benefit in our trade, it doesn’t make sense to default to capital improvements as our standard approach.
