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.

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:

a. 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
b. Real property held by the taxpayer primarily for sale to customers in the ordinary
course of his trade or business; or
c. 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
d. Real property used in trade or business of the taxpayer.

Taxpayers engaged in the real estate business are:

a. real estate dealers
b. real estate developers, and/or
c. real estate lessors.

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

RULES IN DETERMINING CAPITAL OR ORDINARY ASSET

a) ORDINARY ASSETS of taxpayers engaged in the real estate business:
1. All real properties acquired by the real estate dealer
2. All real properties acquired by the real estate developer, whether developed or
undeveloped as of the time of acquisition
3. 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
4. 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

NOTES: Registration with the Human Settlements Adjudication Commission (formerly 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.

*consummation during the preceding year of at least six (6) taxable real estate sale transactions,
regardless of amount shall constitute as habitually engaged in trade

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.
If taxpayer is engaged in real estate business, all real properties are ordinary asset even if idle or
abandoned (conversion is not allowed)

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.

AUTOMATIC CONVERSION
Properties classified as ordinary assets for being used in business are automatically converted
into capital assets upon showing of proof that the same have not been used in business for
more than two (2) years prior to the consummation of the taxable transactions involving said
properties.

c) In the case of taxpayers who changed its real estate business to a non-real estate business, real
properties held by these taxpayers 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.

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:

1. 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.

2. 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.

3. 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.

h) 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
DETERMINATION OF AMOUNT AND RECOGNITION OF GAIN OR LOSS

(A) Computation of Gain or Loss. – The gain from the sale or other disposition of property shall
be the excess of the amount realized therefrom over the basis or adjusted basis for
determining gain, and the loss shall be the excess of the basis or adjusted basis for determining
loss over the amount realized. The amount realized from the sale or other disposition of
property shall be the sum of money received plus the fair market value of the property (other
than money) received.

(B) Basis for Determining Gain or Loss from Sale or Disposition of Property. – the basis of property
shall be:

1. Purchase - Acquisition cost

2. Inheritance - Fair market price or value as of the date of acquisition
3. Gift/Donation – shall be the same as if it would be in the hands of the donor OR the
last preceding owner by whom it was not acquired by gift, except that if such basis is
greater than the fair market value of the property at the time of the gift then, for
purposes of determining loss, the basis shall be such fair market value
4. Acquired for less than an adequate consideration in money or money’s worth –
amount paid by the transferee for the property

Exercises: Compute the Gain or Loss

1. Acquired by purchase: Nicanor bought a car amounting to Php 1,000,000.00. He sold the
same for Php 100,000.

2. Nicanor inherited a car valued at the time of inheritance Php 1 Million. Currently, the market
value is appraised at Php 3 Million. He sold the car for Php 5 Million.

3. Nicanor received a laptop valued at Php 100,000.00 by way of donation from JV. JV
purchased the laptop at Php 120,000.00. Nicanor sold the property at Php 150,000.00.

4. Nicanor purchased a watch for only Php 100,000.00 where the fair market value of which is
Php 500,000.00. He sold the property for Php 1,000,000.00