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Ordinary Asset versus Capital Asset

Ive 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 realestate 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, capitalgains 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 sellers 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.
Capital vs. Ordinary Assets
CAPITAL
VS.
ORDINARY
ASSET
How can you determine whether a particular real property is a capital
asset
or
an
ordinary
asset?
a) Real properties shall be classified with respect to taxpayers engaged in
the real estate business as follows:
i) All real properties acquired by the real estate dealer shall be
considered
as
ordinary
assets.
ii) All real properties acquired by the real estate developer, whether
developed or undeveloped as of the time of acquisition, and all real
properties which are held by the real estate developer primarily for
sale or for lease to customers in the ordinary course of his trade or
business or which would properly be included in the inventory of the
taxpayer if on hand at the close of the taxable year and all real
properties used in the trade or business, whether in the form of land,
building, or other improvements, shall be considered as ordinary
assets.
iii) All real properties of the real estate lessor, whether land, building
and/or improvements, which are for lease/rent or being offered for
lease/rent, or otherwise for use or being used in the trade or business
shall
likewise
be
considered
as
ordinary
assets.
iv) All real properties acquired in the course of trade or business by a
taxpayer habitually engaged in the sale of real property shall be
considered
as
ordinary
assets.
Note: Registration with the HLURB or HUDCC as a real estate dealer
or developer shall be sufficient for a taxpayer to be considered as
habitually
engaged
in
the
sale
of
real
estate.
If the taxpayer is not registered with the HLURB or HUDCC as a real
estate dealer or developer, he/it may nevertheless be deemed to be
engaged in the real estate business through the establishment of
substantial relevant evidence (such as consummation during the
preceding year of at least six (6) taxable real estate sale
transactions, regardless of amount; registration as habitually
engaged in real estate business with the Local Government Unit or

the Bureau of Internal Revenue, etc.)


b) In the case of taxpayer not engaged in the real estate business, real
properties, whether land, building, or other improvements, which are used
or being used or have been previously used in trade or business of the
taxpayer
shall
be
considered
as
ordinary
assets.
c) In the case of taxpayers who changed its real estate business to a nonreal estate business, real properties held by these taxpayer shall remain
to
be
treated
as
ordinary
assets.
d) In the case of taxpayers who originally registered to be engaged in the
real estate business but failed to subsequently operate, all real properties
acquired by them shall continue to be treated as ordinary assets.
e) Real properties formerly forming part of the stock in trade of a taxpayer
engaged in the real estate business, or formerly being used in the trade or
business of a taxpayer engaged or not engaged in the real estate
business, which were later on abandoned and became idle, shall continue
to be treated as ordinary assets. Provided however, that properties
classified as ordinary assets for being used in business by a taxpayer
engaged in business other than real estate business are automatically
converted into capital assets upon showing proof that the same have not
been used in business for more than two years prior to the consummation
of
the
taxable
transactions
involving
said
properties
f) Real properties classified as capital or ordinary asset in the hands of the
seller/transferor may change their character in the hands of the
buyer/transferee. The classification of such property in the hands of the
buyer/transferee shall be determined in accordance with the following
rules:
i) Real property transferred through succession or donation to the
heir or donee who is not engaged in the real estate business with
respect to the real property inherited or donated, and who does not
subsequently use such property in trade or business, shall be
considered as a capital asset in the hands of the heir or donee.
ii) Real property received as dividend by the stockholders who are
not engaged in the real estate business and who do not subsequently
use such property in trade or business, shall be considered as a
capital asset in the hands of the recipients even if the corporation
which declared the real property dividends is engaged in real estate
business.
iii) The real property received in an exchange shall be treated as
ordinary asset in the hands of the case of a tax-free exchange by
taxpayer not engaged in real estate business to a taxpayer who is
engaged in real estate business, or to a taxpayer who, even if not
engaged in real estate business, will use in business the property

received in exchange.
g) In the case of involuntary transfers of real properties, including
expropriations or foreclosure sale, the involuntariness of such sale shall
have no effect on the classification of such real property in the hands of
the involuntary seller, either as capital asset or ordinary asset as the case
may be.

What is the difference between the Final Withholding Tax (FWT)


and the CWT?

The FWT and the CWT are the two basic kinds of withholding taxes. The
FWT is a tax wherein the payer withholds an amount from the payees
income, and pays this amount to the government instead on behalf of the
payee. The payee then no longer needs to file an income tax return for
this income. The CWT is similar in the sense that the payer also withholds
an amount of the payees income and pays this to the government.
However, this amount withheld is usually just an estimate the payee is
still required to file an income tax return to report the income and to pay
the difference between the tax withheld and the real amount due on the
income.
The FWT is usually applicable to indirect sources of income, such as
income from dividends, interest, royalties, capital gains from sale of
property, etc, and income of foreign companies and their employees. The
CWT, on the other hand, is usually applicable to income of Filipinos from
employment and/or fees received.
What kinds of income are subject to the CWT?
Basically, incomes that are subject to the CWT are incomes from
employment (compensation income), and fees such as professional fees,
talent fees, rental income, service income, etc.
At what rates is the CWT imposed?
Like the final withholding tax, the CWT is imposed at different rated,
depending on the type of income being taxed.

b. Compensation Income Tax

Compensation income is defined as salaries or fees, taxable bonuses, and


fringe benefits which are exempted from the fringe benefits tax. These
include:
1. Compensation paid in kind (services paid for in something other than
money)
2. Living quarters or meals provided by the employer in addition to the
employees salary

If these are furnished for the convenience of the


employer, they are not included as compensation
income.

3. Pensions, retirement, and separation pay (except for some exemptions)


4. Transportation, representation, and other allowances

Amounts paid specifically for traveling, representation,


or other necessary expenses reasonably expected to
be incurred by the employees are not included as
compensation if certain conditions are met.

5. Vacation and sick leave allowances

Monetized value of unused vacation leaves credits of


10 days or less within a year are not included as
compensation income.

6. Service fees paid to an employee of a nonresident alien individual or a


foreign entity
7. Payment for services performed outside the Philippines by a resident
citizen for any individual or entity in the Philippines (regardless whether
they are domestic or foreign)
Compensation income withheld is a creditable tax, meaning one no
longer has to pay the amount that has already been withheld when filing
an income tax return. The compensation income is creditable to regular
income tax, and so therefore has the same rates.
Income tax rates:
P10,000 and below

5%

P10,000 to P30,000

P500 + 10% of the excess over P10,000

P30,000 to P70,000

P2,500 + 15% of the excess over P30,000

P70,000 to P140,000

P8,500 + 20% of the excess over P70,000

P140,000 to P250,000

P22,500 + 25% of the excess over P140,000

P250,000 to P500,000

P50,000 + 30% of the excess over P250,000

P500,000 and above

P125,000
P500,000

35%* of

the

excess

over

What are the benefits exempted from the withholding tax on


compensation?

1.

Retirement benefits provided for by the law and those received


under a reasonable private benefit plan maintained by the employer
2.
Amounts received by an official or employee or his heirs due to
death, sickness, etc., or any cause beyond the employees control
3.
Social security benefits, pensions, and the like received from foreign
government agencies by Filipino citizens or resident aliens.
4.
Benefits due to any individual residing in the Philippines under U.S.
laws administered by the U.S. Veterans Administration
5.
SSS benefits
6.
GSIS benefits
7.
Facilities and privileges of a relatively small value and furnished by
an employer as a means of promoting goodwill, efficiency of an employee,
etc.
8.
Tips or gratuities paid to an employee by customers
9.
Payment for agricultural labor paid entirely in products of the farm
where the labor was performed
10.
Income from domestic services in a private home
11.
Payment for occasional or incidental labor which is not done in
connection to the employers trade or business
12.
Payment for services by a citizen or resident of the Philippines by a
foreign government or an international organization
13.
Proceeds of life insurance paid to the beneficiaries upon death of the
insured
14.
Amount received by the insured as a return of premium

15.
Compensation for injuries, sickness, or damages awarded by suit or
agreement
16.
Income exempt under treaty
17.
13th month pay and other benefits not exceeding P30,000
18.
GSIS, SSS, union dues, and other contributions by individual
employees

Are there any exemptions


withholding tax?

from

the

compensation

income

If an individual receives an annual income of P60,000 (P5,000 per month)


or less, he has the option of either having compensation income withheld
(he no longer needs to file his income tax), or simply filing his income tax
(compensation will no longer be subject to withholding).

When do the payers who withhold income payments pay these as


tax to the government?
For ordinary withholding agents, the deadline for paying the withheld tax
is on or before the 10th day following the month in which the withholding
was made. However, if income was withheld from the compensation
income of December, then the deadline of payment is January 25 of the
next year.
For large taxpayers, the deadline is on or before the 25 th day of the
following month.
Where does one file and pay the withheld tax?
Filing and payment is made with authorized agent banks in the Revenue
District Office that has jurisdiction over the area of the business of the
payer who is withholding the income.
o

Q
One of the notable exemptions is found in Republic Act (RA) No. 4917 (An
Act Providing that Retirement Benefits of Employees of Private Firms shall
not be subject to Attachment, Levy, Execution, or any Tax whatsoever),
now embodied in Section 32(B)(6)(a) of the Tax Code which states, among
others, that retirement benefits received by officials and employees of
private firms in accordance with a reasonable private benefit plan
maintained by the employer shall be exempt from income tax, provided:
(1) The retiring official or employee has been in the service of the same

employer for at least 10 years; (2) The retiring official or employee is not
less than 50 years of age at the time of his retirement. (3) The retiring
official or employee should not have previously availed of the privilege
under the retirement benefit plan of the same or another employer.