Some Questions and Answers Concerning the Freeport Exemption

Business personal property that is only located in Texas for a temporary period of time (less than 175 days) is considered freeport goods. Depending on the taxing jurisdiction where a business is located, such goods may qualify for the freeport exemption allowed by the Texas Constitution and the Texas Tax Code.

However, the freeport exemption appears to be one tax reduction opportunity most overlooked by business owners.

Freeport goods consist of personal property that is "acquired in or imported into" Texas to be forwarded to a location outside of Texas. However, there is no requirement that the initial acquisition or import is for the purpose of export. If a taxpayer acquires or imports the property under the belief that it will remain in Texas, but subsequently ships the property out of the state, then the property could qualify as freeport. The initial intent is not determinative of qualification.

The key qualification requirements are that the property must be in Texas for the purpose of "assembling, storing, manufacturing, processing, or fabricating" by the taxpayer and that the property must exit Texas within 175 days after the acquisition or import of the property.

Below are answers to a few of the questions that we have received concerning the freeport exemption.

May a taxpayer obtain freeport exemption at more than one location within the state?

There is nothing in the Texas Tax Code or otherwise which prevents a taxpayer from obtaining a freeport exemption at multiple locations within the state. The only thing that might prevent a qualified freeport from being granted would be if a warehouse were located in taxing units that do not allow freeport exemptions. When the freeport exemption was first enacted, taxing units were allowed to opt out of the exemption. Some taxing units did opt out of the exemption and have retained the right to tax property that would otherwise be considered freeport goods. Thus, if one warehouse were located in a freeport-granting jurisdiction and a second warehouse were located in a non-freeport-granting jurisdiction, then inventory located in the second warehouse would receive no exemption. However, if both warehouses were located in freeport-granting jurisdictions, then both warehouses would receive a freeport exemption.

.Exemption applications must be filed for both locations. It is possible that the freeport exemption percentage would be the same for each location because of the calculation method. The calculation method is to take the total cost of goods shipped out of the state within 175 days in the previous year divided by the total cost of goods sold in the previous year. The calculation is actually based on the previous year information. This percentage is then applied to the market value of the goods at the warehouse on January 1 of the current tax year.

Thus, for example, the freeport may calculate to be 30 percent. If warehouse one had $1 million in goods and warehouse two had $3 million in goods, then freeport exemptions of $300,000 would be granted at warehouse one and $900,000 would be granted at warehouse two.

If there were a situation where one warehouse only stored goods to be used within the state of Texas and thus those goods remained in the state past the 175-day window, then that warehouse might not qualify for any freeport exemption. This would not, however, prevent the other warehouse from receiving the exemption for qualified goods.

Is the freeport exemption limited to the warehouse from which goods are actually shipped?

There is nothing in the Texas Tax Code that restricts the freeport exemption to the warehouse from which goods are eventually shipped out of state.

A freeport exemption is granted under the Tax Code for any property that is "assembled, manufactured, repaired, maintained, processed, or fabricated" in Texas but shipped out of the state within 175 days. Such states Section 11.251 of the Tax Code. However, the Texas Constitution, from which the exemption derives, does not use the words "repaired" or "maintained," though these could be included within the assembly, manufacture, process, and fabrication provisions of the Constitution. However, the Constitution also refers to goods that are stored in Texas, a description not included in the Tax Code.

Thus, there appears little doubt that action taken by a taxpayer in gathering and storing goods from out of state to eventually be shipped to other locations in the state and then shipped from those locations out of state, would qualify the goods for potential freeport application. For example, a wholesaler might import inventory from out of Texas to a central location such as an airport warehouse, transport that inventory to another holding warehouse in the state from which orders are processed, and then ship the goods from this second warehouse to various locations inside and outside of Texas.

The key requirement is that the goods must be shipped out of the state within 175 days of arriving in the state. If goods are stored at one warehouse and then shipped to another warehouse, both in the state of Texas, both warehouses qualify for the exemption, provided that the goods are eventually shipped out of the state within 175 days of arriving in the state. The key dates are not when the goods are shipped from warehouse to warehouse, but when the goods are transported into the state and then transported out of the state. As long as the difference in these dates is 175 days or less, the goods should qualify as freeport.

Must at least 50% of goods be shipped out of state in order to qualify for a freeport exemption?

There is a common misstatement regarding freeport goods. Because of the 175-day requirement, it is often stated that inventory must turn twice a year. With 365 days in a year and a 175-day freeport requirement, this statement appears based on dividing 365 by 175 with a result of a little over 2, or "twice a year."

It is also possible that the idea of "twice a year" comes from the statutory provision relating to determination of component parts held in bulk as freeport goods. Section 11.231(e) states that a chief appraiser may use "the average time" that a component part was in the state to determine whether component parts were transported out of the state within the 175-day period. In other words, because component parts may ship into and out of the state regularly, it is not necessary to show that each individual and specific component part qualifies. The qualification can be determined on a time average for such parts. Thus, the average time for component parts held in bulk could be said to be twice a year. This averaging, however, only relates to component parts held in bulk and not to all forms of freeport goods.

The "twice a year" reference has sometimes been translated into a 50% out-of-state requirement.

However, there is no minimum amount of inventory that must be shipped out of state in order to qualify for freeport exemption. As stated before, the exemption percentage is determined by dividing the cost of goods shipped out of the state within 175 days by the total cost of goods sold in the previous year. In theory, this percentage would stay roughly the same, but will in fact fluctuate each year based on market conditions. The freeport exemption could be any percentage from 1% to 100%.

The purpose of freeport is to exempt property that is considered to only be in this state for a short period of time and is considered to be a part of interstate commerce. Depending on a company's product, only a small portion or all of its goods may be shipped out of state within the 175-day period. Despite claims (especially those from some appraisal districts) to the contrary, there is no minimum threshold for the freeport.

If you have any questions about the contents of this article, please contact the GPD Property Tax Section at propertytax@gpd.com.