You invested $300,000 constructing that 6' fence surrounding your storage building. You used brick pillars and installed a security access entrance gate. Yesterday, during the sales tax audit, the auditor requested to see the invoice for that fence. No big deal you think…until the auditor presents an assessment for $18,000 sales tax, not including interest and penalties. You freak out! How can this be subject to sales tax? The auditor replies "It’s a business fixture and it's subject to sales tax"
In Ohio the difference between business fixture and real property determines who pays sales tax and how much. Construction contractors are considered end users on the materials they install on real property contracts. They pay sales tax on the cost of the materials they purchase, and the invoice to the owner will not include sales tax. Contrasting that, business fixtures are considered tangible personal property, meaning they are subject to sales tax. As such, the same contractor purchases those same materials tax free under a resale exemption, and the invoice will include sales tax based on the invoice cost. As such, the overall cost of the job will be greater simply because the sales tax charged will include the contractor's profit.
At first blush one might think it's not hard to understand the difference between real property and a business fixture. Ohio has two statutes which define real property and personal property. However a reading of each can cause confusion because they look similar to each other. Much case law has been devoted over the differences between the two, with Ohio Court decisions appearing to be conflicting. Some cases have concluded property one thinks of as a business fixture to be real property, while others have concluded exactly the opposite.
Let's look at those definitions and see where the confusion lies.
Real Property: Ohio Revised Code §5701.02 defines Real property to include land itself… all growing crops, including deciduous and evergreen trees, plants, and shrubs, with all things contained therein, and, unless otherwise specified in this section or section 5701.03 of the Revised Code, all buildings, structures, improvements, and fixtures of whatever kind on the land.
Moving on, we find this statute defines a fixture as "an item of tangible personal property that has become permanently attached or affixed to the land or to a building, structure, or improvement, and that primarily benefits the realty and not the business, if any, conducted by the occupant on the premises".
Personal Property: Ohio Revised Code §5701.03 defines personal property as "every tangible thing that is the subject of ownership, whether animate or inanimate, including a business fixture, and that does not constitute real property, as defined in section 5701.02 of the Revised Code" What is a business fixture? A business fixture is "an item of tangible personal property that has become permanently attached or affixed to the land or to a building, structure, or improvement, and that primarily benefits the business conducted by the occupant on the premises and not the realty."
Note how both definitions contain the term "tangible personal property"; thus the confusion. However, I've underlined the key parts that are important to understand the differences. One is from the definition of real property and the other is from the definition of personal property. As such, it's important to read these two laws together to understand them
For a fixture to qualify as real property it must primarily benefit the land itself and not the business conducted on the land. Likewise, a fixture is a business fixture if it primarily benefits the business operating on the land. How can we determine which is which?
Here are 3 key questions to consider:
#1: Would the fixture exist on the land if the business were not present? This is a very powerful question to ask as it goes right to the reason the fixture is there. In our sign example; you would not have invested as much in the fence had it not been for the business you conducted on the property. A strong indication it's a business fixture.
#2: Would the fixture be of any benefit to the land if the business terminated? This is an excellent follow up question to the first. In our fence example, if you closed your doors today, would the fence be of any benefit to the building? Likely not making it a stronger indication it’s a business fixture.
#3: If the owner of the land is unrelated to the owner of the business conducted on the land, which party believes it to own the fixture? Let's assume you don't own the land, you're just leasing it from someone you didn't know. If the land owner installed the fence on the property, it's possible that fence would be considered real property, since the land owner has no vested interest in your business outside that monthly rent check.
Many an assessment has withstood challenge because a fixture built on real property was determined to be a business fixture. While the law tries to define each, confusion over the common term "tangible personal property" makes it difficult to be certain; and common sense is of no help either. Make no mistake, a misclassification of a business fixture as real property will result in a large assessment, given the significant dollars invested. As such, an analysis by an independent advisor will pay dividends in preserving cash flow.
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Other recent “Ohio (OH)” posts by Guy Nevers, CPA, MT:
- Tax on Temporary Labor in Ohio; A Not So Temporary Headache!
- Ohio Sales Tax: Amazon Law Bill Introduced
- Ohio Sales Tax: County "Add-On" Rules & Tools
- Ohio Sales Tax: Exemptions Outside the Tax Code
- Ohio Sales Tax: Business Fixtures or Real Property? (3 Key Questions)