Notes in Tax Review

8/18/2019 Notes in Tax Review

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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

!ow this is important to understand as the consequence may lead to

paying de"ciency in ta# , penalty and delay in processing the transfer of

$itle which is really something that can be avoided

In sales of real property, the character or nature of the property will

determine the ta#es that will be due Real property can either be a capital

asset or an ordinary asset %apital assets have been de"ned as all pieces

of real property held by a ta#payer, whether or not connected with his

trade or business, and which are not included among the pieces of real

property considered as ordinary assets &n the other hand, ordinary

assets are de"ned by enumeration, and refer to all pieces of real property

e#cluded from the de"nition of capital assets, namely' stock in trade of a

ta#payer or other real property of a kind which would properly be included

in the inventory of the ta#payer if on hand at the close of the ta#able

year( or real property held by the ta#payer primarily for sale to customers

in the ordinary course of his trade or business( or real property used in

trade or business )ie, buildings and*or improvements+ of a character that

is subect to the allowance for depreciation( or real property used in trade

or business of the ta#payer

$he "rst 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 $he last two sets of ordinary assets can beheld by people or companies that are not necessarily in the real-estate

business, but are used in other types of businesses E#amples are resort

facilities owned by a resort owner, a factory used for the manufacture of

products, o.ce units or buildings used as corporate headquarters, hotels,

shopping malls, among others $he Bureau of Internal Revenue )BIR+ has

clari"ed 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

/hen what is sold is real property classi"ed as a capital asset, capital-gains ta# )%0$+ at the rate of 1 percent of the gross selling price or the

fair market value of the property, whichever is higher, will be due for

payment %0$ is a "nal income ta# It is paid under a premise that the

seller derived a presumed capital gain 2ence, even in the event that a

seller of real property classi"ed as a capital asset did not really derive any

gain from the transaction )and even su3ered a loss+, the %0$ is

nonetheless due and payable %0$ must be paid within 45 days from the

date of the sale

6n interesting point to note is that a sale of a real property classi"ed as a

capital asset may be e#empt from %0$ If an individual sells his principalresidence and the proceeds thereof are fully utilized in acquiring or


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constructing a new principal residence within 78 calendar months from

the date of sale, then the transaction shall be e#empt from %0$, subect to

compliance with administrative requirements imposed by the BIR

In contrast, if Real property classi"ed as an ordinary asset is sold, the

ta#es due and payable will have to be determined at two points in time

9irst, once the deed of sale is e#ecuted, creditable withholding ta# )%/$+

will have to be paid to the BIR $he withholding-ta# rate shall depend on

the situation of the ta#payer $he rate of 1 percent shall apply if the seller

is not habitually engaged in the real-estate business but the property is

classi"ed as an ordinary asset, such as the e#amples previously given If

the seller is habitually engaged in the real- estate business, the rate

depends on the selling price, ie, if :;55,555 or less, 7; percent( if more

than :;55,555 up to :< million, 4 percent( if more than :< million, ;

percent $he ta# base is also the gross selling price or the fair market

value of the property, whichever is higher $he obligation to withhold and

remit the %/$ to the BIR generally falls on the buyer %/$ must be paid

within 75 days after the end of each month when the sale occurred

In addition to the withholding ta#, the sale of real property held as an

ordinary asset will also be subect to value-added ta# )=6$+ at the rate of

7< percent of the gross selling price or the fair market value of the

property, whichever is higher =6$ is paid to the BIR by the seller, but the

seller is allowed to pass this on to the buyer $here are, however, sales of

real property that are not subect to =6$, such as a sale of a residential lot

where its value does not e#ceed :7; million, or the sale of a residential

house and lot where the value does not e#ceed :;5,555, or the sale of real property utilized for

socialized housing with a price ceiling of :


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It should be stressed that the %/$ which was paid on the sale of real

property classi"ed as an ordinary asset is merely an advance or a prepaid

income ta#, which will be deducted from the income ta# payable of the

seller If the seller’s gain is substantial thereby resulting in an income ta#

payable that is higher than the %/$ that was previously paid to the BIR,

then the seller will have no choice but pay an additional income ta# for

the quarter or for the previous year If the seller derives a loss and*or the

%/$ that has been remitted to the BIR on his*its behalf is more than the

income ta# due, the seller may opt to use the Ae#cess prepaid ta# for

subsequent ta#able quarters or years, or apply for a ta# credit from the

BIR

Capital vs. Ordinary Assets

CAPITAL VS. ORDINARY ASSET

2ow can you determine whether a particular real property is a capitalasset or an ordinary assetCa+ Real properties shall be classi"ed with respect to ta#payers engaged inthe real estate business as follows'

i+ 6ll real properties acquired by the real estate dealer shall beconsidered as ordinary assetsii+ 6ll real properties acquired by the real estate developer, whetherdeveloped or undeveloped as of the time of acquisition, and all realproperties which are held by the real estate developer primarily for

sale or for lease to customers in the ordinary course of his trade orbusiness or which would properly be included in the inventory of theta#payer if on hand at the close of the ta#able year and all realproperties used in the trade or business, whether in the form of land,building, or other improvements, shall be considered as ordinaryassetsiii+ 6ll real properties of the real estate lessor, whether land, buildingand*or improvements, which are for lease*rent or being o3ered forlease*rent, or otherwise for use or being used in the trade or businessshall likewise be considered as ordinary assetsiv+ 6ll real properties acquired in the course of trade or business by a

ta#payer habitually engaged in the sale of real property shall beconsidered as ordinary assets!ote' Registration with the 2DRB or 2?%% as a real estate dealeror developer shall be su.cient for a ta#payer to be considered ashabitually engaged in the sale of real estateIf the ta#payer is not registered with the 2DRB or 2?%% as a realestate dealer or developer, he*it may nevertheless be deemed to beengaged in the real estate business through the establishment of substantial relevant evidence )such as consummation during thepreceding year of at least si# )1+ ta#able real estate saletransactions, regardless of amount( registration as habituallyengaged in real estate business with the Docal 0overnment nit or


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the Bureau of Internal Revenue, etc+

b+ In the case of ta#payer not engaged in the real estate business, realproperties, whether land, building, or other improvements, which are used

or being used or have been previously used in trade or business of theta#payer shall be considered as ordinary assets

c+ In the case of ta#payers who changed its real estate business to a non-real estate business, real properties held by these ta#payer shall remainto be treated as ordinary assets

d+ In the case of ta#payers who originally registered to be engaged in thereal estate business but failed to subsequently operate, all real propertiesacquired by them shall continue to be treated as ordinary assets

e+ Real properties formerly forming part of the stock in trade of a ta#payerengaged in the real estate business, or formerly being used in the trade orbusiness of a ta#payer engaged or not engaged in the real estatebusiness, which were later on abandoned and became idle, shall continueto be treated as ordinary assets :rovided however, that propertiesclassi"ed as ordinary assets for being used in business by a ta#payerengaged in business other than real estate business are automaticallyconverted into capital assets upon showing proof that the same have notbeen used in business for more than two years prior to the consummationof the ta#able transactions involving said properties

f+ Real properties classi"ed as capital or ordinary asset in the hands of theseller*transferor may change their character in the hands of thebuyer*transferee $he classi"cation of such property in the hands of thebuyer*transferee shall be determined in accordance with the followingrules'

i+ Real property transferred through succession or donation to theheir or donee who is not engaged in the real estate business withrespect to the real property inherited or donated, and who does notsubsequently use such property in trade or business, shall be

considered as a capital asset in the hands of the heir or doneeii+ Real property received as dividend by the stockholders who arenot engaged in the real estate business and who do not subsequentlyuse such property in trade or business, shall be considered as acapital asset in the hands of the recipients even if the corporationwhich declared the real property dividends is engaged in real estatebusinessiii+ $he real property received in an e#change shall be treated asordinary asset in the hands of the case of a ta#-free e#change byta#payer not engaged in real estate business to a ta#payer who is

engaged in real estate business, or to a ta#payer who, even if notengaged in real estate business, will use in business the property


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received in e#change

g+ In the case of involuntary transfers of real properties, includinge#propriations or foreclosure sale, the involuntariness of such sale shall

have no e3ect on the classi"cation of such real property in the hands of the involuntary seller, either as capital asset or ordinary asset as the casemay be

What is the dieren!e "et#een the $inal Withh%ldin& Ta' ($WT)and the CWT*

$he 9/$ and the %/$ are the two basic kinds of withholding ta#es $he9/$ is a ta# wherein the payer withholds an amount from the payee’sincome, and pays this amount to the government instead on behalf of thepayee $he payee then no longer needs to "le an income ta# return forthis income $he %/$ is similar in the sense that the payer also withholdsan amount of the payee’s income and pays this to the government2owever, this amount withheld is usually ust an estimate F the payee isstill required to "le an income ta# return to report the income and to paythe di3erence between the ta# withheld and the real amount due on theincome

$he 9/$ is usually applicable to indirect sources of income, such asincome from dividends, interest, royalties, capital gains from sale of property, etc, and income of foreign companies and their employees $he%/$, on the other hand, is usually applicable to income of 9ilipinos fromemployment and*or fees received

What +inds %, in!%-e are su"e!t t% the CWT*

Basically, incomes that are subect to the %/$ are incomes fromemployment )compensation income+, and fees such as professional fees,talent fees, rental income, service income, etc

At #hat rates is the CWT i-p%sed*

Dike the "nal withholding ta#, the %/$ is imposed at di3erent rated,depending on the type of income being ta#ed

b %ompensation Income $a#


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%ompensation income is de"ned as salaries or fees, ta#able bonuses, andfringe bene"ts which are e#empted from the fringe bene"ts ta# $heseinclude'

7 %ompensation paid in kind )services paid for in something other than

money+


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:45,555 to :>5,555 :5,555 to :7G5,555 :8,;55 J 5,555

:7G5,555 to :


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7; %ompensation for inuries, sickness, or damages awarded by suit oragreement

71 Income e#empt under treaty7> 74th month pay and other bene"ts not e#ceeding :45,55578 0@I@, @@@, union dues, and other contributions by individual

employees

Are there any e'e-pti%ns ,r%- the !%-pensati%n in!%-e#ithh%ldin& ta'*

If an individual receives an annual income of :15,555 ):;,555 per month+or less, he has the option of either having compensation income withheld)he no longer needs to "le his income ta#+, or simply "ling his income ta#)compensation will no longer be subect to withholding+

When d% the payers #h% #ithh%ld in!%-e pay-ents pay these asta' t% the &%vern-ent*

9or ordinary withholding agents, the deadline for paying the withheld ta#is on or before the 75th day following the month in which the withholding

was made 2owever, if income was withheld from the compensationincome of ?ecember, then the deadline of payment is Manuary


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employer for at least 75 years( )

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Notes in Tax Review