Ordinary Asset versus Capital Asset
I’ve been a Real Estate Broker for quite sometime now and the issue of ordinary asset and capital asset is still something that puzzles me, more so, the property owners as there are unique cases every now and then. Now this is important to understand as the consequence may lead to paying deficiency in tax , penalty and delay in processing the transfer of Title which is really something that can be avoided.
In sales of real property, the character or nature of the property will determine the taxes that will be due. Real property can either be a capital asset or an ordinary asset. Capital assets have been defined as all pieces of real property held by a taxpayer, whether or not connected with his trade or business, and which are not included among the pieces of real property considered as ordinary assets. On the other hand, ordinary assets are defined by enumeration, and refer to all pieces of real property excluded from the definition of capital assets, namely: stock in trade of a taxpayer or other real property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or real property used in trade or business (i.e., buildings and/or improvements) of a character that is subject to the allowance for depreciation; or real property used in trade or business of the taxpayer.
The first two sets of ordinary assets are those usually held by people or companies engaged in the buy and sell of pieces of real property, or real- estate dealers and developers. The last two sets of ordinary assets can be held by people or companies that are not necessarily in the real-estate business, but are used in other types of businesses. Examples are resort facilities owned by a resort owner, a factory used for the manufacture of products, office units or buildings used as corporate headquarters, hotels, shopping malls, among others. The Bureau of Internal Revenue (BIR) has clarified in its regulations and rulings that real property does not lose its character as an ordinary asset even if it becomes fully depreciated, or if circumstances prevent it from being used in business, or if there is discontinuance in its use in business.
When what is sold is real property classified as a capital asset, capital-gains tax (CGT) at the rate of 6 percent of the gross selling price or the fair market value of the property, whichever is higher, will be due for payment. CGT is a final income tax. It is paid under a premise that the seller derived a presumed capital gain. Hence, even in the event that a seller of real property classified as a capital asset did not really derive any gain from the transaction (and even suffered a loss), the CGT is nonetheless due and payable. CGT must be paid within 30 days from the date of the sale.
An interesting point to note is that a sale of a real property classified as a capital asset may be exempt from CGT. If an individual sells his principal residence and the proceeds thereof are fully utilized in acquiring or constructing a new principal residence within 18 calendar months from the date of sale, then the transaction shall be exempt from CGT, subject to compliance with administrative requirements imposed by the BIR.
In contrast, if Real property classified as an ordinary asset is sold, the taxes due and payable will have to be determined at two points in time. First, once the deed of sale is executed, creditable withholding tax (CWT) will have to be paid to the BIR. The withholding-tax rate shall depend on the situation of the taxpayer. The rate of 6 percent shall apply if the seller is not habitually engaged in the real-estate business but the property is classified as an ordinary asset, such as the examples previously given. If the seller is habitually engaged in the real- estate business, the rate depends on the selling price, i.e., if P500,000 or less, 1.5 percent; if more than P500,000 up to P2 million, 3 percent; if more than P2 million, 5 percent. The tax base is also the gross selling price or the fair market value of the property, whichever is higher. The obligation to withhold and remit the CWT to the BIR generally falls on the buyer. CWT must be paid within 10 days after the end of each month when the sale occurred.
In addition to the withholding tax, the sale of real property held as an ordinary asset will also be subject to value-added tax (VAT) at the rate of 12 percent of the gross selling price or the fair market value of the property, whichever is higher. VAT is paid to the BIR by the seller, but the seller is allowed to pass this on to the buyer. There are, however, sales of real property that are not subject to VAT, such as a sale of a residential lot where its value does not exceed P1.5 million, or the sale of a residential house and lot where the value does not exceed P2.5 million, or the sale of real property utilized for low-cost housing where the selling price per unit is not more than P750,000, or the sale of real property utilized for socialized housing with a price ceiling of P225,000 per unit.
Whether the real property sold is a capital asset or an ordinary asset, documentary stamp tax (DST) at the rate of P15 for every P1,000 of the gross selling price or the fair market value of the property, whichever is higher, will likewise have to be paid. The parties to a sale agree on who will be liable to pay the DST, but in practice, this is, more often than not, shouldered by the buyer. DST must be paid within the first five days of the month following the date of the sale.
The second point in time when taxes on the sale of real property classified as an ordinary asset will have to be determined is when the seller is preparing his quarterly and/or annual income-tax return, depending on when the sale transaction occurred. The seller will need to compute the gain or loss on the sale of his/its real property and consider such gain or loss in determining his/its net taxable income for the quarter or for the year. That taxable income will be subjected to the 30-percent income-tax rate, if a corporation, or the graduated rates, if an individual (and where the highest rate is still at 32 percent). For corporations, the rule on minimum corporate income tax will be taken into account in computing its income tax payable.
It should be stressed that the CWT which was paid on the sale of real property classified as an ordinary asset is merely an advance or a prepaid income tax, which will be deducted from the income tax payable of the seller. If the seller’s gain is substantial thereby resulting in an income tax payable that is higher than the CWT that was previously paid to the BIR, then the seller will have no choice but pay an additional income tax for the quarter or for the previous year. If the seller derives a loss and/or the CWT that has been remitted to the BIR on his/its behalf is more than the income tax due, the seller may opt to use the “excess” prepaid tax for subsequent taxable quarters or years, or apply for a tax credit from the BIR.
As always, it’s always good to seek the services of a “Taxation” Lawyer.
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Robert G. Sarmiento Properties
Professional Affiliation :
Philippine Association of Real Estate Boards
Member, City of Taguig Real Estate Board 2016 – 2019
Real Estate Broker’s Association of the Philippines 2000 – 2015
President, San Juan 2008, 2009
Philippine Association of Real Estate Boards
San Juan Mandaluyong Chapter 1998, 1999
PRC # 6569
PRC Lecturer’s License # 0294
Email : [email protected]
Website : www.robertgsarmiento.com
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