Capital Gains Tax, Part 2: Persons Engaged in the Business of Real Estate

When is a real property used in trade or business to be considered as ordinary asset? The law classifies real property as ordinary asset by exclusion depending on who holds the said real property, or depending on whether the owner is a real estate dealer, a real estate developer, or a real estate lessor. Thus, if the owner is any of these three, then the real property is deemed used in trade or business and, hence, classified as ordinary asset. Conversely if you are not among the three types of persons enumerated above, the real property under your ownership is not deemed used in trade or business.

But who are these real estate dealers, real estate developers, and real estate lessors in the first place?

1. A real estate dealer refers to 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.
2. A real estate developer, on the other hand, refers to 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.
3. Finally, a real estate lessor refers 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 a lessor of real properties being rented out or offered for rent.

For real estate dealers and developers, registration with either the Housing and Land Use Regulatory Board (HLURB) or the Housing and Urban Development Coordinating Council (HUDCC) is sufficient in order for them to be deemed engaged in the business of real estate. If they are not registered, they may still be deemed engaged in the real estate business by establishing substantial relevant evidence. The law defines this as consummation during the preceding year of at least six taxable real estate sale transactions.

In the case of a taxpayer not engaged in the real estate business, real properties – whether land, building, or other improvements – that are being used or have been previously used in trade or business of the taxpayer shall be considered as ordinary assets.

In the case of taxpayers who changed their real estate business into a non-real-estate one, real properties held by these taxpayers shall remain to be treated as ordinary assets. 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.

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:

1. A real property transferred through succession or donation to an heir or donee, who in turn 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.
2. A 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 that declared the real property dividends is engaged in real estate business.
3. The real property received in an exchange shall be treated as ordinary asset in the case of a tax-free exchange between a 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 the exchange.
4. 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.