The Colorado sales tax exemption for manufacturing equipment removes the state’s 2.9% sales and use tax from qualifying machinery, machine tools, and their parts, so long as the purchase clears four tests laid out in C.R.S. § 39-26-709. It covers most purchases and many leases of equipment used directly in production. It does not automatically cover local sales tax in home-rule cities, which is where manufacturers most often get burned.
The Four Criteria Every Purchase Must Meet
Miss any one of these and the full state and state-administered local sales tax applies to the purchase.
- The equipment must be used in Colorado. Machinery bought in-state but shipped to an out-of-state facility does not qualify.
- The purchase must exceed $500. The statute reads “in excess of five hundred dollars,” so a $500 invoice falls short by a penny. The threshold applies per unit, not per invoice: ten tools at $100 each do not qualify even though the total is $1,000.
- The equipment must be Section 38 property, meaning the type that would have qualified for the federal investment tax credit under Section 38 of the Internal Revenue Code of 1954. In practice, that means depreciable tangible personal property with a useful life of three years or more. Office furniture and buildings generally do not count.
- The equipment must be used directly and predominantly in manufacturing, meaning more than 50% of its operating time on actual production of tangible personal property for sale or profit. Idle time and maintenance time do not count on either side of that split.
The Section 38 test filters out short-lived consumable tools, general-purpose office equipment, and real property improvements, even when those items sit on the factory floor.
What “Directly in Manufacturing” Actually Means
Manufacturing under the statute means producing a new product that has a different name, character, or use than the materials that went into it. Cutting lumber into boards qualifies. Sorting and repackaging goods usually does not, because the underlying product doesn’t change.
Direct manufacturing use begins when raw material leaves plant inventory on a contiguous plant site and ends when the product reaches its completed form, including packaging if packaging is part of the finished good. Machinery that moves material from one production step to the next in a continuous flow counts. So does equipment used for in-process testing during production.
Equipment That Does Not Qualify
The dividing line usually comes down to where the machine sits in the production sequence. A conveyor feeding raw material into a stamping press qualifies. A conveyor loading finished cartons onto delivery trucks does not. Once the product is complete, the equipment touching it is outside the exemption.
Machinery used for repair, maintenance, or general upkeep of other equipment is not direct manufacturing use, even when the machine being serviced is itself exempt. Accounting-office computers, forklifts that only move finished inventory in a warehouse, and HVAC serving employee comfort areas all fall outside.
Replacement parts installed in qualifying machinery are eligible, provided the underlying machine still meets all four criteria. Supplies consumed in routine maintenance, such as lubricants and cleaning solvents, are not.
Home-Rule Cities Set Their Own Rules
The state exemption reaches Colorado’s 2.9% state sales tax and the local sales taxes the Department of Revenue administers for statutory cities and counties. It does not reach sales and use taxes administered by home-rule cities.
Colorado has dozens of home-rule municipalities running their own sales tax systems, including Denver, Colorado Springs, Aurora, Boulder, and Fort Collins. Some mirror the state manufacturing exemption. Others do not. Before assuming a purchase is fully tax-free, contact the home-rule city where the equipment will be used and confirm its treatment. The Department of Revenue will not intervene in a home-rule tax dispute.
Claiming the Exemption at Purchase
The cleanest path is to avoid paying the tax in the first place. The buyer completes Form DR 1191, “Sales Tax Exemption on Purchases of Machinery and Machine Tools,” and gives it to the vendor at or before the sale. The form asks for the business’s legal name, address, Colorado tax account number, and a description of the equipment and its manufacturing use. One copy goes to the seller, one to the Department of Revenue, one stays in the buyer’s file.
The DR 1191 is the vendor’s documentation for not collecting state sales tax, but the accuracy of every statement on it is the buyer’s responsibility. If an audit later determines the equipment did not qualify, the tax liability lands on the buyer, not the seller.
Getting a Refund If You Already Paid
If you paid sales tax on equipment that should have been exempt, there is a required first step most businesses skip: try to recover the overpayment from the retailer before petitioning the state. Only if the retailer cannot or will not refund the tax do you file Form DR 0137B, the Claim for Refund of Tax Paid to Vendors.
The DR 0137B requires the purchase date, vendor name, and exact amount of state sales tax paid. Filing is available through Revenue Online at Colorado.gov/RevenueOnline, or on paper. Include invoices showing per-unit pricing to confirm the $500 threshold, plus evidence that you first sought a refund from the vendor.
Refund claims must generally be filed within three years of the date the tax was paid. If the department denies the claim, it issues a written explanation and you can protest the denial.
Records to Keep
The burden of proof on an exemption falls on the business claiming it. Keep purchase invoices showing per-unit pricing, copies of every DR 1191 you submitted, documentation of how each machine is used and what share of its operating time is manufacturing, and evidence that the equipment meets the Section 38 property test. Businesses that treat this as an afterthought tend to lose exemptions on audit even when the purchase genuinely qualified.
Related Exemptions Worth Knowing About
Two adjacent programs often apply to the same manufacturer. Electricity, coal, natural gas, fuel oil, steam, coke, and nuclear fuel consumed directly in manufacturing are exempt under a separate provision; where the same utility feed serves both production and non-production uses like office lighting, tax is owed on the non-exempt share, and the split is typically documented on Form DR 1666.
Manufacturers located in a designated enterprise zone can also claim a 3% state income tax credit on qualifying business personal property investments, including manufacturing machinery. The investment must be used exclusively in the enterprise zone for the first year of ownership, used equipment purchases are capped at $150,000 per year, and applications are due by December 31 of the tax year in which the investment was made. Unused credit carries forward for up to 14 years. This is a separate income tax credit that stacks on top of the sales tax exemption; it does not replace it.