Authority, legal basis, and referenced rules
- Section 1 grounds these regulations on Section 244 of the National Internal Revenue Code of 1997.
- Section 1 specifically implements Section 39(A)(1), in relation to Sections 24(D), 25(A)(3), 25(B) and 27(D)(5) and Sections 24(A), 25(A) & (B), 27(A), 28(A)(1) and 28(B)(1), and the MCIT provisions under Sections 27(E) and 28(A)(2).
- Section 1 also anchors the classification guidelines for use in determining the correct tax treatment (capital gains tax versus ordinary income tax and MCIT).
- Section 2(b) and Section 4 reference tax withholding under Section 2.57.2(J) of Revenue Regulations No. 2-98, as amended, and certain final withholding under Section 2.57.1(I) of Revenue Regulations No. 2-98, as amended.
- Section 2(c) defines “real property” by reference to Article 415 of Republic Act No. 386 (Civil Code of the Philippines).
- The regulations’ authority to issue is reflected in the adoption by the Secretary of Finance and the recommending approval by the Commissioner of Internal Revenue.
Policy and purpose statement
- Section 1 establishes the purpose of these regulations: to provide guidelines in determining whether a particular real property is a capital asset or an ordinary asset.
- The classification rules under these regulations are designed for the purpose of applying the capital gains tax, the ordinary income tax, and the minimum corporate income tax (MCIT) under the Code provisions cited in Section 1.
Definitions governing classification
- Capital assets are defined in Section 2(a) as all real properties held by a taxpayer, whether or not connected with trade or business, that are not included among the real properties considered as ordinary assets under Section 39(A)(1) of the Code.
- Ordinary assets are defined in Section 2(b) as all real properties excluded from the definition of capital assets under Section 39(A)(1) of the Code, specifically:
- (1) stock in trade or other real property of a kind properly included in the inventory if on hand at the close of the taxable year;
- (2) real property held primarily for sale to customers in the ordinary course of trade or business;
- (3) real property used in trade or business (buildings and/or improvements) of a character subject to depreciation under Section 34(F) of the Code;
- (4) real property used in trade or business of the taxpayer.
- Section 2(b) provides special treatment for banks: real properties acquired by banks through foreclosure sales are considered ordinary assets, and banks are not considered habitually engaged in the real estate business for purposes of determining the applicable rate of withholding tax imposed under Section 2.57.2(J) of Revenue Regulations No. 2-98, as amended.
- Real property is defined in Section 2(c) as having the same meaning attributed under Article 415 of Republic Act No. 386 (Civil Code of the Philippines).
- Real estate dealer is defined in Section 2(d) as any person engaged in 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 is defined in Section 2(e) as any person engaged in 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 is defined in Section 2(f) as any person engaged in 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 are defined in Section 2(g) as real estate dealers, real estate developers, and/or real estate lessors.
- Section 2(g) provides that a taxpayer whose primary purpose of engaging in business, or whose Articles of Incorporation state that its primary purpose is to engage in the real estate business is deemed engaged in the real estate business for purposes of these regulations.
Coverage: who and what properties
- Section 1 applies to the determination of whether a particular real property is a capital asset or an ordinary asset.
- Section 2 covers “real properties” held by a taxpayer and provides classifications relevant to the capital gains and ordinary income tax rules of the Code.
- Section 3 provides classification rules based on the taxpayer’s character, including:
- taxpayers engaged in the real estate business (dealer, developer, lessor, and taxpayers habitually engaged);
- taxpayers not engaged in the real estate business;
- taxpayers changing from real estate to non-real estate business;
- taxpayers registered for real estate business who later fail to operate;
- treatment of abandoned and idle real properties;
- classification shifts for buyers/transferees in succession, donation, dividend, exchange, and involuntary transfers.
- The regulations treat classification outcomes as controlling for determining applicable taxes in Section 4 on sale, exchange, or other disposition of real property located in the Philippines and, separately, for real property not located in the Philippines.
Substantive classification rules
- All real properties acquired by a real estate dealer are classified as ordinary assets under Section 3(a)(1).
- All real properties acquired by a real estate developer are classified as ordinary assets under Section 3(a)(2), including properties:
- whether developed or undeveloped at acquisition;
- developed or offered for sale or lease to customers in the ordinary course of business;
- properly included in inventory at the close of the taxable year;
- used in the trade or business in any form such as land, buildings, or other improvements.
- All real properties of a real estate lessor are classified as ordinary assets under Section 3(a)(3), including land and/or improvements for lease/rent, offered for lease/rent, or otherwise used or being used in the trade or business.
- Taxpayers habitually engaged in the real estate business have their acquired real properties classified as ordinary assets under Section 3(a)(4), including registration with the HLURB or HUDCC as sufficient.
- Section 3(a)(4) allows a taxpayer not registered with HLURB or HUDCC to be deemed engaged in the real estate business through substantial relevant evidence, including consummation during the preceding year of at least six (6) taxable real estate sale transactions, regardless of amount, and other registrations with a Local Government Unit or the Bureau of Internal Revenue.
- A property purchased for future use in the real estate business does not lose its character as an ordinary asset even if later thwarted by circumstances beyond the taxpayer’s control, and discontinuance of active use does not change its character previously established as a business property under Section 3(a)(4).
- For taxpayers not engaged in the real estate business, real properties used or being used or previously used in the trade or business are treated as ordinary assets under Section 3(b), including buildings and/or improvements subject to depreciation and lands used in the trade or business.
- Section 3(b) provides that a depreciable asset does not lose its character as an ordinary asset even if fully depreciated or even if depreciation was not taken during the period of ownership.
- Section 3(b) provides that monetary consideration or presence/absence of profit is not significant; real property used for business purposes remains an ordinary asset whether for the benefit of the owner or its members or stockholders.
- Section 3(b) provides that real property used by an exempt corporation in its exempt operations, such as a corporation included in the enumeration of Section 30 of the Code, is not considered used for business purposes and is treated as a capital asset under these regulations.
- Section 3(b) provides that certain residential properties owned by an individual engaged in business are treated as capital assets when not used in trade or business, as evidenced by:
- a certification from the Barangay Chairman; and
- for condominium unit, townhouse or apartment, additional validation from available records of the Bureau of Internal Revenue.
- For taxpayers changing business from real estate to non-real estate business, Section 3(c) provides that the change of business or amendment of primary purpose does not result in reclassification of real property from ordinary asset to capital asset.
- Section 3(c) directs that for purposes of issuing the certificate authorizing registration (CAR) or tax clearance certificate (TCL), the appropriate BIR officer must determine whether a corporation purporting to be not engaged in the real estate business has amended its primary purpose from real estate to non-real estate at any time.
- For taxpayers originally registered as engaged in real estate business but later fail to subsequently operate, Section 3(d) provides that all real properties originally acquired continue to be treated as ordinary assets.
- For abandoned and idle properties, Section 3(e) provides that real properties formerly part of stock in trade or formerly used in the trade or business of a taxpayer engaged or not engaged in the real estate business, when later abandoned and become idle, continue to be treated as ordinary assets.
- Section 3(e) further provides that real property initially acquired by a taxpayer engaged in real estate business does not convert into a capital asset even if subsequently abandoned or becomes idle.
- Section 3(e) establishes an automatic conversion rule for certain ordinary assets used in business by a taxpayer engaged in business other than real estate business (as defined in Section 2(g)): such properties automatically convert into capital assets upon proof that the properties have not been used in business for more than two (2) years prior to the consummation of the taxable transactions involving the properties.
- For transfers to a buyer/transferee, Section 3(f) establishes that the capital/ordinary character in the buyer’s hands is determined by specific rules:
- Succession or donation to an heir or donee not engaged in the real estate business with respect to the property inherited or donated, and who does not subsequently use such property in trade or business, results in the property being treated as a capital asset in the hands of the heir or donee.
- Dividend to stockholders not engaged in the real estate business who do not subsequently use such property in trade or business results in capital asset treatment in the hands of recipients, even if the declaring corporation is engaged in real estate business.
- In an exchange, real property is treated as an ordinary asset in the hands of the transferee in the case of a tax-free exchange by a taxpayer not engaged in real estate business to a taxpayer engaged in real estate business, or to a taxpayer who, even if not engaged, will use the property received in business.
- For involuntary transfers, Section 3(g) provides that involuntariness has no effect on classification in the hands of the involuntary seller—classification remains as capital asset or ordinary asset based on the seller’s characterization.
- Section 3(g) provides illustrative treatment: foreclosure of real properties forming part of the inventory of a real estate dealer results in treating the property as ordinary assets for purposes of determining the applicable tax on the foreclosure sale, while the buyer’s characterization follows the transferee rules under Section 3(f).
Applicable taxes upon disposition
- Section 4(a) establishes that gains/income from sale, exchange, or other disposition of real properties are subject to applicable taxes under the Code unless exempt, depending on whether the property is a capital asset or ordinary asset.
- Individuals and similar taxpayers (individual citizens including estates and trusts, resident aliens, and non-resident aliens engaged in trade or business in the Philippines) are governed by Section 4(a).
- For capital asset real property dispositions by individuals and similar taxpayers, Section 4(a)(i) imposes a six percent (6%) capital gains tax on capital gains presumed realized from sale/exchange/disposition of real property located in the Philippines, computed based on either the gross selling price or the current fair market value determined under Section 6(E) of the Code, whichever is higher.
- Section 4(a)(i) provides a Government option: when the buyer is the Government or any of its political subdivisions or agencies or a government-owned-or-controlled corporation, the individual seller (including estate or trust) may compute liability on either the six percent (6%) capital gains tax under Sections 24(D)(1)/25(A)(3) or the graduated tax rates under Sections 24(A)(1)(c) or 25(A)(1) of the Code.
- For ordinary asset dispositions by individuals and similar taxpayers, Section 4(a)(ii) requires creditable withholding tax (expanded) under Section 2.57.2(J) of Revenue Regulations No. 2-98, as amended, based on the gross selling price or current fair market value under Section 6(E), whichever is higher, and consequently applies the ordinary income tax under Sections 24(A)(1)(c) or 25(A)(1) of the Code based on net taxable income.
- Non-resident aliens not engaged in trade or business in the Philippines are governed by Section 4(b).
- For non-resident aliens not engaged in trade or business, Section 4(b) imposes a six percent (6%) capital gains tax under Section 25(B) in relation to Section 24(D)(1) on capital gains presumed realized from sale/exchange/disposition of real property located in the Philippines, computed using the gross selling price or current fair market value under Section 6(E), whichever is higher.
- Domestic corporations are governed by Section 4(c):
- Capital asset dispositions: Section 4(c)(i) imposes a capital gains tax of six percent (6%) on the gross selling price or current fair market value under Section 6(E), whichever is higher, on lands/buildings located in the Philippines classified as capital assets.
- Ordinary asset dispositions and other real property not treated as capital asset: Section 4(c)(ii) requires creditable withholding tax (expanded) under Section 2.57.2(J) of Revenue Regulations No. 2-98, as amended and consequently subjects the income to ordinary income tax under Section 27(A) of the Code.
- MCIT option: Section 4(c)(ii) provides that instead of ordinary income tax, domestic corporations may become subject to MCIT under Section 27(E), whichever is applicable.
- Resident foreign corporations are governed by Section 4(d): real property located in the Philippines sold by such corporations is subject to creditable withholding tax (expanded) under Section 2.57.2(J) of Revenue Regulations No. 2-98, as amended, and consequently to ordinary income tax under Section 28(A)(1) or MCIT under Section 28(A)(2), whichever is applicable.
- Non-resident foreign corporations are governed by Section 4(e): gains from sale of real property located in the Philippines are subject to final withholding tax at thirty-two percent (32%) imposed under Section 2.57.1(I) of Revenue Regulations No. 2-98, as amended, in relation to Section 28(B)(1) of the Code.
- Income/gain from sale of real property not located in the Philippines is governed by Section 4(f):
- For resident citizens and domestic corporations, gains are subject to the income tax imposed in Section 24(A)(1) or Section 27(A) or 27(E) of the Code, as the case may be.
- The income/gain is exempt pursuant to Section 23(B), (D) and (F) of the Code in the case of non-resident citizens, alien individuals and foreign corporations.
Repeal and inconsistency rule
- Section 5 provides that existing BIR rulings, revenue rules, regulations, and other issuances, or portions thereof, inconsistent with these regulations are modified, repealed, or revoked accordingly.