How to Compute Capital Gains Tax on Sale of Real Property

How to Compute Capital Gains Tax on Sale of Real Property in the Philippines? When a person sells real property, classified as “capital asset”, he may be liable for taxes, which include local property taxes, documentary stamp tax and capital gains tax. Capital Gains Tax, as it names suggests is a tax typically imposed on sale or exchange of capital assets. In the following discussions, we will try to guide readers in computing and filing capital gains tax returns on sale of real property. The following also discusses important information, such as the difference between capital assets and ordinary assets, the tax bases and rates used, and the definitions of related terms.

 

What is Capital Gains Tax?

Capital Gains Tax is a tax imposed on the gains presumed to have been realized by the seller from the sale, exchange, or other disposition of capital assets located in the Philippines, including pacto de retro sales and other forms of conditional sale.

This also means that the sale or exchange of ordinary assets (those that are not capital assets) are not subject to capital gains tax, instead, they may be subjected to creditable withholding tax. Below are definitions of capital assets and ordinary assets.

 

What are capital assets?

Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code.

 

What are ordinary assets?

Ordinary assets shall refer to all real properties specifically excluded from the definition of capital assets under Sec. 39(A)(1) of the Code, namely:

1. 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
2. Real property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; or
3. Real property used in trade or business (i.e., buildings and/or improvements) of a character which is subject to the allowance for depreciation provided for under Sec. 34(F) of the Code; or
4. Real property used in trade or business of the taxpayer.

 

Other terms and definitions

The following terms and definitions will guide us in determining and distinguishing capital assets from ordinary assets. Remember that real properties may be classified based on the type of taxpayers engage in the real estate business.

Real property – 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.

Art. 415 states that 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. (334a)

Real estate dealer – any person engaged in the business of buying and selling or exchanging real properties on his own account as a principal and holding himself out as a full or part-time dealer in real estate.

Real estate developer – any person engaged in the business of developing real properties into subdivisions, or building houses on subdivided lots, or constructing residential or commercial units, townhouses and other similar units for his own account and offering them for sale or lease.

Real estate lessor – shall refer to any person engaged in the business of leasing or renting real properties on his own account as a principal and holding himself out as lessor of real properties being rented out or offered for rent.

Taxpayers engaged in the real estate business – refer collectively to real estate dealers, real estate developers, and/or real estate lessors. A taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation states that its primary purpose is to engage in the real estate business shall be deemed to be engaged in the real estate business.

Taxpayers not engaged in the real estate business – refer to persons other than real estate dealers, real estate developers and/or real estate lessors.

 

How to determine whether a 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 non-real 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 tax base/rate used for computing Capital Gains Tax on transfer of real property?

There shall be imposed a final tax rate of six percent (6%) based on whichever is higher of the following:

1) The fair market value as determined by the Commissioner (zonal value);
2) The fair market value as shown in the Schedule of Values of the Provincial and City Assessors; or
3) The selling price of the property or fair market value of the property received in an exchange transaction.

Capital gains presumed to have been realized from the sale or disposition of their principal residence by natural persons, the proceeds of which is fully utilized in acquiring or constructing a new principal residence within eighteen (18) calendar months from the date of sale or disposition, shall be exempt from payment of the capital gains tax: Provided, That the historical cost or adjusted basis of the real property sold or disposed shall be carried over to the new principal residence built or acquired:

Provided, further, that the Commissioner shall have been duly notified by the taxpayer within thirty (30) days from the date of sale or disposition through a prescribed return (Form 1706) and “Sworn Declaration of Intent”, as prescribed in Revenue Regulations No. 13-99, of his intention to avail of the tax exemption herein mentioned: Provided, still further, That the said tax exemption can only be availed of once every ten (10) years: Provided, finally, that if there is no full utilization of the proceeds of sale or disposition, the portion of the gain presumed to have been realized from the sale or disposition shall be subject to capital gains tax. For this purpose, the gross selling price or fair market value at the time of sale, whichever is higher, shall be multiplied by a fraction which the unutilized amount bears to the gross selling price in order to determine the taxable portion and the tax due.

If the seller fails to utilize the proceeds of sale or disposition in full or in part within the 18-month reglementary period, his right of exemption from the capital gains tax did not arise to the extent of the unutilized amount, in which event, the tax due thereon shall immediately become due and demandable on the 31st day after the date of the sale, exchange or disposition of principal residence.

 

Sample computation of capital gains tax on sale of real property

Example: Mr. Santos sells a residential lot in Pasig City with a floor area of 200sqm on cash with Selling Price of P3 Million. Mr. Santos is not engaged in a real estate business. The proceeds from the sale will be used by Mr. Santos for his trip to US and other personal expenses.  The following are the fair market value information of the real property:

1. Fair Market Value as determined by BIR Commissioner (Zonal Value/BIR Rules):
1a. Land: P1,600,000 (let us say BIR Zonal value is P8,000/sqm [200 x 8,000=1,600,000])
1b. Improvement: P1,200,000

2. Fair Market Value as determined by Provincial/City Assessor’s (per latest Tax Declaration):
2a. Land: P1,400,000
2b. Improvement: P1,300,000

How much is the Capital Gains Tax?

Answer/solution:

Step 1. Determine the highest fair value (FMV):

Total FMV1 (1a + 1b): P2,800,000
Total FMV2 (2a + 2b): P2,700,000
Total FMV3 (1a + 2b): P2,900,000
Total FMV4 (2a + 1b): P2,600,000

The Highest FMV is FMV3: P2,900,000. This is the FV we will use in the step 2.

Step 2. Determine the higher between FMV and Selling Price:

FMV = P2,900,000
Selling Price = P3,000,000

The higher value is the selling price P3,000,000. This is our tax base for computing Capital Gains Tax.

Step 3. Calculate Capital Gains Tax.

DST = P3,000,000 x 6%
DST = P180,000

 

What is the BIR form used for filing Capital Gains Tax on Sale of Real Property?

The form used for filing Capital Gains Tax return or declaration is BIR Form No. 1706 – For Onerous Transfer of Real Property Classified as Capital Asset (both Taxable and Exempt). Please click here to download the form.

 

Who are required to file BIR Form No. 1706?

This return is filed by all persons (natural or juridical) whether resident or non-resident, including Estates and Trusts, who sells, exchanges, or disposes of a real property located in the Philippines classified as capital asset as defined under Sec. 39 (A)(1) of RA 8424 for the purpose of securing a Tax Clearance Certificate to effect transfer of ownership (title) of the property from the seller to the buyer.

However, filing of the return is no longer required when the real property transaction involves the following:

  • it is not classified as a capital asset
  • not located in the Philippines
  • disposition is gratuitous
  • disposition is pursuant to the Comprehensive Agrarian Reform

 

When and Where to File?

The return shall be filed by the seller with any Authorized Agent Bank (AAB) of the Revenue District Office (RDO) having jurisdiction over the place where the property being transferred is located.

In places where there are no AABs, the return shall be filed with the Revenue Collection Officer or duly Authorized City or Municipal Treasurer of the Revenue District Office having jurisdiction over the place where the property being transferred is located.

The return shall be filed within thirty (30) days following each sale, exchange or disposition of real property.

In case of installment sale where the taxpayer is allowed to pay the tax by installment under certain conditions and requirements, the return shall be filed within thirty (30) days following the receipt of the first down payment or following each subsequent installment payment, whichever is applicable.

One return shall be filed for every real property sold, exchanged or disposed of (for cash sale, or foreclosure sale), or every installment payment made (for installment sale).

For the attachments required and other information, please see BIR Form 1706. For computing Documentary Stamp Tax DST on transfer of real property, classified as capital asset, please read our article on “How to compute DST on transfer of Real Property Tax in the Philippines”.

Source: For more information, please refer to BIR Revenue Regulations No. 07-03, BIR website capital gains tax info, BIR Form 1706, NIRC of the Philippines, Civil Code of the Philippines.

Disclaimer: This article was published for informational use only. Subsequent and new laws, regulations, issuances and rulings may render the whole or part of the article obsolete or incorrect. For more clarifications and inquiries, please the visit the BIR RDO in your jurisdiction.

Victorino Abrugar is a retired CPA practitioner, a blogger, speaker, and an entrepreneur. He's the CEO of Optixor, Inc., a digital marketing company based in the Philippines. Follow him on Twitter at @viclogic.