Capital Gains Tax vs.

Income Tax
When there is a sale of real estate, automatically people think that they have to pay
Capital Gains Tax (CGT). This is not necessarily the case. CGT is a tax on the gain
from the sale of capital assets. Regular corporate income tax (RCIT) [for corporations]
and regular income tax [for individuals] apply to the sale of ordinary assets while CGT
applies to the sale of capital assets.

Thus, we first have to determine whether the asset being sold is a capital or an ordinary
asset so as to know the proper tax rate to be used and the BIR form to be used, among
others.

Capital assets vs. Ordinary assets

The term capital assets is defined negatively in Section 39(A)(1) of the Tax Code as
follows:

(1) Capital Assets. the term capital assets means property held by the taxpayer
(whether or not connected with his trade or business), but does not include

stock in trade of the taxpayer or other 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
property held by the taxpayer primarily for sale to customers in the ordinary course of his
trade or business, or
property used in the trade or business, of a character which is subject to the allowance for
depreciation provided in Subsection (F) of Section 34;
or real property used in trade or business of the taxpayer.

As applied to the real estate industry, the terms capital assets and ordinary assets
are defined in Section 2(c) of Revenue Regulations (RR) No. 7-2003 dated December
27, 2002. Its essentially the same as the above definition.

It has an additional provision, though, on real properties acquired by banks through

foreclosure sales the same are considered as their ordinary assets but banks shall not
be considered as habitually engaged in the real estate business for purposes of
determining the applicable rate of expanded withholding tax.

Since we are talking about the sale of real property here, we need to know the definition
of real property. Section 2(c) of RR No. 7-2003 states that Real property shall have
the same meaning attributed to that term under Article 415 of Republic Act No. 386,
otherwise known as the Civil Code of the Philippines. Article 415 of the Civil Code
provides:

Art. 415. The following are immovable property:

(1) Land, buildings, roads and constructions of all kinds adhered to the soil;

(2) Trees, plants, and growing fruits, while they are attached to the land or form an integral
part of an immovable;

(3) Everything attached to an immovable in a fixed manner, in such a way that it cannot be
separated therefrom without breaking the material or deterioration of the object;

(4) Statues, reliefs, paintings or other objects for use or ornamentation, placed in buildings
or on lands by the owner of the immovable in such a manner that it reveals the intention to
attach them permanently to the tenements;

(5) Machinery, receptacles, instruments or implements intended by the owner of the

tenement for an industry or works which may be carried on in a building or on a piece of
land, and which tend directly to meet the needs of the said industry or works;

(6) Animal houses, pigeon-houses, beehives, fish ponds or breeding places of similar
nature, in case their owner has placed them or preserves them with the intention to have
them permanently attached to the land, and forming a permanent part of it; the animals in
these places are included;

(7) Fertilizer actually used on a piece of land;

(8) Mines, quarries, and slag dumps, while the matter thereof forms part of the bed, and
waters either running or stagnant;

(9) Docks and structures which, though floating, are intended by their nature and object to
remain at a fixed place on a river, lake, or coast;
(10) Contracts for public works, and servitudes and other real rights over immovable
property.

Thus, it appears that it is not only the sale of land and buildings or houses which we
should be focusing on, but also the sale of the above.

As RR No. 7-2003 is a very important rule on real estate, I have included the said
regulations in this post for your reference. Read it in its entirety. You may download a
copy here. Answers to frequently asked questions can be found in this document.

In simple terms, if the property is not ordinarily held for sale (as inventory) or used in
business and subject to depreciation, then the property is a capital asset. Now, if a
seller is engaged in the real estate business, and the property is one he holds out for
sale to the public, then the property may be considered as an ordinary asset.

[Note that there may be instances when a seller is engaged in the real estate business
but the property is not held for sale or used in business or was idle for a long time this
is one of the instances when the property may be considered a capital asset.]

Conversely, if a seller is not engaged in the real estate business, and the property is not
used in business and subject to depreciation, the property may be considered as a
capital asset, the sale of which is subject to CGT.

Section 3 of RR No. 7-2003 provides the Guidelines in Determining Whether a

Particular Real Property is a Capital Asset or Ordinary Asset.

Tax Rate to be Used

When the real property which is a capital asset to the seller is sold, the gross selling
price or fair market value (FMV) [zonal value], whichever is higher, will be subject to 6%
CGT. Please refer to the BIR
website http://www.bir.gov.ph/zonalvalues/zonalvalues.htmfor the zonal values.

Technically, its not really only the gain (selling price less cost) which is taxed, because
even if the seller suffered a loss (that is, the selling price is lower than the original
acquisition cost of the property), there will still be CGT, because a gain is always
presumed.

On the other hand, if the seller is engaged in the real estate business, and the real
property sold is an ordinary asset, the sale will be subject to RCIT [or minimum
corporate income tax (MCIT), when applicable] if the taxpayer is a corporation and
income tax if the seller is an individual.
The proceeds from the sale of the real property will be included in the sellers global
income (meaning income from all sources note that domestic corporations and
resident citizens are taxed on all sources of income, whether from within or outside the
country) and only the net income, after allowable deductions such as depreciation,
losses, etc. will be subjected to RCIT, MCIT, or regular income tax, whichever is
applicable.

Under Republic Act No. 9337, the RCIT is now 30% on net taxable income (beginning
on January 1, 2009, down from 35%). The regular income tax for individuals remains at
32%.

Please note that there is an exception to the application of the CGT, and that is the sale
of a principal residence (your own home). This deserves a separate discussion as I
intend to take advantage of this when we purchase our next residence.

BIR procedure
Assuming that you are interested in buying a property from a seller who is an individual
and who is not engaged in the real estate business, the seller needs to pay CGT on the
sale of his real property, unless you have made an agreement that you as the buyer will
shoulder this.

The seller needs to file BIR Form No. 1706 within thirty (30) days after each sale,
exchange, transfer or other disposition of real property. You can download BIR Form
No. 1706 here.

Documentary Requirements
1 ) One original copy and one photocopy of the Notarized Deed of Sale or Exchange

2 ) Photocopy of the Transfer Certificate of Title; Original Certificate of Title; or

Condominium Certificate of Title

3 ) Certified True Copy of the tax declaration on the lot and/or improvement during nearest
time of sale

4 ) Certificate of No Improvement issued by the Assessors office where the property has
no declared improvement, if applicable or Sworn Declaration/Affidavit of No Improvement by
at least one (1) of the transferees

5 ) Copy of BIR Ruling for tax exemption confirmed by BIR, if applicable

6 ) Duly approved Tax Debit Memo, if applicable

7 ) Sworn Declaration of Interest as prescribed under Revenue Regulations 13-99, if the

transaction is tax-exempt

8 ) Documents supporting the exemption

Additional requirements may be requested for presentation during audit of the tax case
depending upon existing audit procedures.

How to File the Capital Gains Tax Return

You just have to file the Capital Gains Tax return in triplicate (two copies for the BIR and
one copy for the taxpayer) with the Authorized Agent Bank (AAB) in the Revenue
District where the property is located, along with the documentary requirements and the
tax due.

In places where there are no AAB, the return will be filed directly with the Revenue
Collection Officer or Authorized City or Municipal Treasurer. You can view the Revenue
District Offices (RDO) here: http://www.bir.gov.ph/directory/rdo.htm. Click on the
concerned RDO.

For example, if you click on RDO 48 West Makati, you will get
tohttp://www.bir.gov.ph/directory/rdoinner.htm#48. The names of the Revenue District
Officer and Assistant Revenue District Officer as well as their contact numbers and e-
mail addresses, and the address of the Revenue District Office and the AABs within the
said RDO may be found there.

Sample CGT computation

A residential condominium in Makati City with a floor area of 50sqm has a Selling Price
(SP) of 1.0M. The existing zonal value per square meter for that condo in Makati is
currently Php50,000/sqm. You have called the owner and found out that he is not
engaged in the real estate business.

He also told you that as part of the deal, the buyer shall shoulder the CGT. As the
buyer, how much is the CGT which you will have to pay the seller on top of the selling
price?

First lets compute for the Fair market Value (FMV):

FMV=Zonal Value x Floor Area
=50,000 pesos/sqm x 50sqm
=2,500,000 pesos

Since FMV is higher than SP, we shall use FMV to compute the CGT:

CGT=6% x FMV
=0.06 x 2,500,000 pesos
=150,000 pesos

Therefore, the buyer shall have to shell out an additional 150,000 pesos.

Note that while technically, the CGT is always the responsibility of the seller, and that if
the buyer shoulders the CGT, it is in effect part of the selling price to be compared to
FMV for purposes of computing the 6% CGT, I noted that the practice of banks is to
compute the CGT this way.

Now, what if you called up the seller and told him that you are willing to buy the property
but he should shoulder the capital gains tax as the seller, then he counters your offer
and says he is willing to shoulder the CGT up to his selling price and the buyer shall
shoulder the CGT for the excess or the difference between the SP and FMV, how do
you compute for the CGT?

First, lets compute for the excess or difference between the SP and the FMV:

Excess=FMV-SP
=2,500,000pesos 1,000,000pesos
=1,500,000 pesos

Now, lets compute for the CGT to be shouldered by the buyer:

CGT for the buyer =6% x Excess

=0.06 x 1,500,000 pesos
=90,000 pesos

The CGT to be shouldered by the seller is as follows:

CGT=6% x SP
=0.06 x 1,000,000 pesos
=60,000 pesos
Take note that the total CGT is 90,000 pesos + 60,000 pesos = 150,000 pesos, which is
consistent with our first computation. The CGT was just split between the buyer and the
seller.

As investors, we should always try to negotiate for the best terms and in relation to this
particular example, always try to have the other party shoulder the CGT.

The seller will still be the one to file the CGT and he shall have to file the return in an
Authorized Agent Bank within the Revenue District where the property is located in
Makati, within 30 days the deed of sale was executed