Owner Direct Purchase Program Benefits

by | Design-Build, Facilities

In the current inflationary climate for construction projects, churches and other non-profits should not be passing up any opportunities to reduce their rapidly rising project costs.  Leveraging their exemption from paying state sales tax is among the most beneficial approaches.

What is a Direct Purchase Program? 

Simply stated, it is a program that a non-profit project owner manages collaboratively with their contractor to take full advantage of their tax-exempt status to reduce construction project costs by not paying sales sale on materials and equipment.

Benefits of a Program

The potential for savings will depend on a number of factors, including the type of project, how deep the project team is willing to go to realize savings, and the resources available on the contractor and owner side to manage the process.  On a typical project it is not unreasonable to save 1-2% of the total project costs, which is typically well worth the investment, especially on larger projects.  

How to Get Started

Ideally a contractor is selected already having experience helping owners manage such a program.  Their experience and capabilities in this area should be addressed in the contractor selection phase.  Contractors who have historically done a lot of church work or public-school work often have such direct purchase program experience.  Even if your contractor has not managed a sales tax savings program in the past, setting up a program together with them is not difficult.  

The Process

The process uses a typical construction contract change order process between the contractor and Owner.  Changes are common in construction projects either due to unforeseen conditions or changes in project scope initiated by a client or architect.  A direct purchase program simply uses deduct change orders to deduct the cost of materials and equipment and the state sales tax that the contractor would be obligated to pay on those purchases from his current contract value with the Owner.  It is best to ensure that direct purchase deducts are not co-mingled with other project changes as it makes the accounting of the total savings easier. 

  1. The contractor will submit a direct purchase deduct change order with detailed back up of all materials and equipment for purchase (including vendor contact information) to the Owner for approval and signature.
  2. Once approved, the owner then initiates direct purchase orders to each vendor for the materials or equipment the contractor would have otherwise purchased themselves.   The benefit is that the owner makes the direct purchase themselves and is not obligated to pay the state sales tax (validated by providing to the vendors a copy of the owner’s state tax exempt certificate).
  3. Typically, the contractor handles the coordination of the delivery of the materials or equipment with the vendor as they would have done if they had purchased directly from the vendor.
  4. A common approach early in the project is for the contractor to submit a monthly direct purchase deduct change order “Tax Bundle” to the Owner for action.  This would occur each month until all materials or equipment intended to be directly purchased are procured.

Example: The contractor has included in his contract $200,000 (including sales tax) for buying concrete materials for a new church addition.  This is in addition to $50,000 of his labor costs for concrete work to be performed.

Contractor submits a deduct change order detailing out the value of the concrete material to be purchased and the tax on the concrete material 

Deduct Concrete Materials ($183,486)

Deduct 9% State Sales Tax on Concrete Materials   ($16,514)   

Total Deduct Change Order ($200,000)

The Owner then writes a direct purchase order to the concrete supplier for $183,486 to purchase the concrete tax free.  When the invoice for the concrete material is received by the Owner, the Owner verifies the quantities and rates with the contractor and then they pay it directly, thereby saving the $16,514 in sales tax. 

With this process applied to as many materials and equipment as practical, an overall savings of 1-2% of the construction contract value is achievable.  On a recent church addition project, the Owner achieved a $78,600 sales tax savings on a construction contract of $4,200,000.  An overall project savings of 1.87%

Considerations:

  • Start with a plan for what can practically be purchased without the cost to manage the additional change orders and direct payments exceeding the value of the tax saved.  For example, large bulk items like concrete, steel, drywall, windows, brick, HVAC units etc. make sense.  Buying toilet accessories and paint may not.  
  • Owners should ensure they have capable and available internal accounting support staff to manage the deduct change orders, direct vendor purchase orders, and payment of invoices to vendors. 
  • Make sure that at the completion of the project that the contractor’s final contract amount (which will have been reduced by all direct purchase deduct change orders) is added to the value of all the direct owner purchases when arriving at the total project construction cost.

With a little planning and effort, nonprofit Owners can be better stewards of the funds entrusted to them by leveraging their unique tax-exempt status. 

Steve Kuhn is the founder of ShareBuilt, a nonprofit organization, that directly connects those in need of new/renovated facilities to AEC organizations with resources to meet those needs and professionals called to serve their communities.

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