Guidelines in Determining Whether a Real Property is a Capital Asset or Ordinary Asset

The Tax Code defines the term “capital assets” in the negative manner. Thus, the term “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include:

1.    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

2.    property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or

3.    property used in the trade or business, of a character which is subject to the allowance for depreciation; or

4.    real property used in trade or business of the taxpayer.

What are the Guidelines in Determining whether Real Property is Capital Asset or Ordinary Asset?

Basically, the determination is whether the seller is engaged in the business of real estate or not.

Actually, there is no specific criterion as to what constitutes “doing” or “engaging in” or “transacting” business. Each case must be judged in the light of its peculiar environmental circumstances.

If the seller is engaged in real estate business, the real property shall be classified as ordinary asset.

In case of a real estate dealer, all properties acquired by the real estate dealer shall be considered as ordinary assets.

In case of a real estate developer, 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 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 likewise be considered as ordinary assets.

So in sum, the real properties are all ordinary assets in the above categories. What is the importance of knowing whether the asset is capital or ordinary? For one, the distinction is material when it comes to payment of taxes.

Please note that if a person is engaged in real estate business, he shall secure a License to Sell from the Department of Human Settlements and Urban Development (DHSUD). It is the central housing authority in the Philippines. It consolidated the duties and functions of the Housing and Urban Development Coordinating Council (HUDCC) and the Housing and Land Use Regulatory Board (HLURB), except for adjudication.

If the seller is 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 the trade or business of the taxpayer shall be considered as ordinary assets. These include buildings and/or improvements subject to depreciation and lands used in the trade or business of the taxpayer.

Last Oct. 3, 2023, BIR issued RMC 99-2023 clarifying the Applicable Taxes on Sale of Real Property Considered as Ordinary Assets of the Seller and Other Relevant Matters.

In this RMC, it is clarified by the BIR that only sellers of real properties classified as “ordinary assets” are required to issue sales invoice. However, if you are engaged in the sale of services, which in this case you do have Service Invoice, the issuance of the Service Invoice is permitted because the sale is merely incidental to its regular business operations of sale of services (or construction).

In case of real estate lessor:

All real properties of the real estate lessor, whether land 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.

In case the seller is habitually engaged in the real estate business:

All real properties acquired in the course of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered as ordinary assets.

Registration with the DHSUD as 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 DHSUD as a real estate dealer or developer, he may nevertheless be deemed to be engaged in the real estate business through the establishment of substantial relevant evidence such as:

1.    Consummation during the preceding year of at least six taxable real estate sale transactions, regardless of amount; or

2.    Registration as habitually engaged in real estate business with the Local Government Unit or the Bureau of Internal Revenue, etc.

A property purchased for future use in the business, even though this purpose is later thwarted by circumstances beyond the taxpayer’s control, does not lose its character as an ordinary asset. Nor does a mere discontinuance of the active use of the property change its character previously established as a business property. [Sec. 3(a)(4), Rev. Regs. No. 7-2003). So once ordinary asset, always an ordinary asset.

Next, Banks are not habitually engaged in real estate business. However, foreclosed real properties of banks are considered as ordinary assets

Rev. Regs. No. 7-2003 dated December 27, 2002 prescribes guidelines in the determination of the nature of real properties provides that real properties acquired by banks through foreclosure sales are considered as their ordinary assets. However, banks shall not be considered as habitually engaged in the real estate business for purposes of determining the applicable rate of expanded withholding tax.

Taxpayer changing business from real estate business to non-real estate business

In the case of a taxpayer who changed its real estate business to a non-real estate business, or who amended its articles of incorporation from a real estate business to a non-real estate business, such as a holding company, manufacturing company, trading company, etc., the change of business or amendment of the primary purpose of the business shall not result in the re-classification of real property held by it from ordinary asset to capital asset. [Sec. 3(c), Rev. Regs. No. 7-2003)].

Treatment of Abandoned and Idle Real Properties

Real properties formerly forming part of the stock in trade of a taxpayer engaged in 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. Real estate initially acquired by a taxpayer engaged in the real estate business shall not result in its conversion into a capital asset even if the same is subsequently abandoned or becomes idle.

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 of 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. [Sec. 3(e), Rev. Regs. No. 7-2003).

Ordinary Assets, always an ordinary asset. If you are into the business of real estate. Otherwise, the ordinary asset of a taxpayer engaged in business other than real estate has the chance of being converted into a capital asset.

Treatment of Real Property Subject of Involuntary Transfer

In the case of involuntary transfers of real properties, including expropriation 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. [Sec. 3(g), Rev. Regs. No. 7-2003).

The above post is for general informational purposes only and is not a substitute professional legal advice. Likewise, the above post does not create a lawyer-client relationship between you and me. While I am a lawyer, I am not your lawyer. It is still best for you to engage the services of your lawyer to address your specific legal concerns, if there is any.

Also, the write ups stated above was written in accordance with the law, rules, and jurisprudence prevailing at the time of writing and posting, and do not include any future developments on the subject matter under discussion.

Thank you for dropping by. I hope we can spend time together here in my website during your coffee break.