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Atty. Mabel Buted discusses the rules on taxation of sale, transfer, and disposition of real properties...

Taxation of Sale of Real Properties

By: Atty. Mabel L. Buted

Mabel L Buted Junior Associate   +63 912 345-8756 This email address is being protected from spambots. You need JavaScript enabled to view it. View Profile

The BIR recently issued revenue issuances providing additional guidelines in relation to the payment of taxes due on real property transactions, especially for properties considered as ordinary assets. Related to this, let’s also revisit the rules to remind us of our tax obligations when dealing with real estate transactions. Real property taxation is indeed complicated – from the proper classification of the property, the determination of the applicable taxes and tax rates, to the timing on the payment of taxes, especially if the payment is under a long-term arrangement or in installment.

The first step in determining the correct taxes due on a sale of real property is to ascertain whether the asset involved is considered ordinary or capital asset. Real properties considered as ordinary assets are those which are primarily held for sale to customers or those that are being used in the trade or business of the taxpayer. All other real properties that are not considered as ordinary assets are capital assets.

Let me discuss first the taxation of sale of “ordinary” real properties. The income or gain arising from the sale or transfer of these assets is subject to the regular income tax. The timing or year for the reporting of such gain and the payment of the tax in the tax return, however, varies. The terms of payment would dictate this. Cash sales definitely require the reporting of income at the time of sale.

What about if the payment term extends to over a year? The portion of the income to be reported and when to be reported depends on the initial payments in the year of sale. If more than 25% of the total contract or selling price is paid in such year, the taxpayer is already required to pay in the year of sale the income tax on the entire gain. On the other hand, if the payments during the year of sale does not exceed 25% of the total amount of consideration, this is treated as a sale on the installment plan, and the income tax is to be paid only on the income in any taxable year corresponding to the proportion of the installment payments actually received in that year, which the total profit realized or to be realized when the property is paid for bears to the total contract price. In other words, for sales made under an installment plan, the entire profit arising from the sale and the income tax due on it is spread over the term of payment of the selling price, based on the amount of collections made during a particular year.

The sale of real properties considered as ordinary assets is also subject to VAT based on the gross selling price or fair market value of the property, whichever is higher. Like in income tax, the 25% criterion is also observed in the determination as to when and how much of the VAT is to be paid. If the 25% threshold is breached, VAT is paid entirely at the year of sale. Otherwise, VAT is paid only upon every installment, based on the collections received.

The sale is also subject to the creditable expanded withholding tax (EWT), with the same basis as the basis for the VAT, that is, whichever is higher between the gross selling price and the fair market value of the property. If total payments in the year of sale exceeded 25%, the EWT is withheld upon the first installment. On the other hand, if the initial payments do not exceed 25%, the EWT is withheld upon every installment if the buyer is engaged in trade or business, while the tax is withheld upon the last installment if the buyer is not engaged in trade or business. The EWT rate ranges from 1.5% to 6%, depending on the amount of the selling price and if the transferor is engaged in real estate business. So apart from the 25% criteria, whether or not the buyer and seller are engaged in trade or business and the amounts involved are also factors in determining the applicability of withholding tax, the applicable EWT rate and the timing for the withholding tax remittances.

Shifting to capital assets, unlike “ordinary” real properties, sale of real properties considered as capital assets are not subject to VAT and to the creditable withholding tax. Also, it is not the gain arising from the sale which is subject to income tax. It is the entire gross selling price or the fair market value of the property (whichever is higher), which is subject to the capital gains (income) tax at 6%.

Real estate transactions are also subject to documentary stamp taxes and to local transfer taxes, both of which are based on the higher of the total consideration or fair market value of the property.

These rules on taxation of the sale, transfer or disposition of real properties have remained unchanged for quite a long time. In the case of the “25% rule,” for example, this can be traced as far back as1940 when the Income Tax Regulations was issued. The real estate industry in the country is booming. As times have changed, perhaps it’s also time to revisit our laws, rules and regulations affecting the taxation of real properties. Changes may need to be introduced to be responsive to the current situation and help keep the development and growth of the industry moving.