This is the second part of a series on the three types of income one can get through real estate investing. If you missed the first part, please read it before reading this. You can find part one here – How to get portfolio income through real estate investing

Earned income is the type of income that only comes in if you work for it. Sometimes it is also referred to as active income. In real estate, we can get earned income by investing for capital gains, and also through commissions or professional fees by acting as a real estate broker or agent. For beginning real estate investors, earned income is arguably the easiest to earn.

Earned income through capital gains

A common way to get earned income through real estate is by investing for capital gains. We can get capital gains through buying and selling properties quickly for a profit, which is more commonly referred to as flipping. Flipping can be further divided into wholesaling or retailing.

Wholesaling

From what I understand, wholesaling is when one ties-up a property under contract, turns around, and sells it to a buyer who is usually another real estate investor for a small but quick profit. The wholesaler basically buys a property below market value and sells it at a higher price but still below market value, leaving enough room for profit for the next buyer. Sometimes it is also possible to just assign the contract.

Retailing

Retailing on the other hand is when you buy a property, renovate or rehabilitate it (hence the term rehabbing), and  then sell  it for a bigger profit as compared to wholesaling. Although flipping is usually associated with quick deals, retailing is also often described as flipping, even if it obviously takes longer to complete.

Wholesaling and retailing examples

In our previous example on portfolio income, I bought a foreclosed property for Php1Million, renovated it, and sold it for Php1.5 Million. That’s a perfect example of a retail deal.

What if I just tied-up the property by putting an earnest money deposit, and then sold it to another real estate investor by assigning the contract to him for a total contract price of Php1.2Million, leaving him with still enough room for a significant profit if he himself would renovate and sell the property for Php1.5Million afterwards? That’s wholesaling! Your profit of Php200,000 is your earned income.

By the way, if one is investing for capital gains through flipping, one can be greatly affected when market conditions deteriorate and property values go down. One may not be able to sell the property at the desired selling price.

Earned income through commissions

Another way to get earned income through real estate would be through commissions, either as a real estate broker or agent. Take note that I said through real estate, not through real estate investing. In my opinion, when one is after commissions, it is not really investing in real estate but is rather selling time and effort, more on this later.

In the Philippines, the common commission rates for brokers are 3% to 6% while agents usually get 2% to 3%, at least that’s what I often see from other real estate brokers and agents. Remember, I am also a licensed real estate broker.

Advantages of earned income

1. You get quick cash – There is a potential for quick cash because of the quick turnaround time for selling the properties when filliping or acting as a broker. Obviously, there is still a need to actually sell the property and close the deals

2. Requires little capital – When you structure a wholesale deal, one might be able to tie-up or get the property under contract with just a little earnest money which means there is little capital needed. If you act as a broker, there is really no capital needed as you are just selling someone else’s property.

Disadvantages of earned income

1. No sales, no income. Effort driven – If you are unable to consistently (1) find a property to flip or to broker and (2) complete the deal by actually selling it and closing the deal, no income comes in.

2. Need buyers or investors lined up – For flipping to work, you obviously have to have a lot of ready buyers or investors lined up to buy the properties from you.

3. Highest tax rates – If you consistently buy and sell properties and the BIR sees that you are already habitually engaged in the real estate business, your earnings will get taxed at earned income levels, and you pay this through income tax. If you end up at the highest tax bracket, your income will get taxed at a rate of 32%, if I’m not mistaken. Take note however that one can still  lower the taxable income through allowable deductions, thereby lessening the payable income tax.

In our example above where the wholesale deal netted a gross profit of Php200,000, one would have to pay income tax amounting to 32% of Php200,000 or Php64,000. If one is also habitually engaged in real estate (you already have at least 6 real estate transactions in the current year), you also have to consider Creditable Withholding Tax (CWT) and VAT if applicable. Yes, you read that right, CWT should be considered instead of Capital Gains Tax (CGT).

If you earn commissions by being a broker or an agent, you also have to pay income tax.

4. Earnings might be inconsistent – Earnings become inconsistent because there will surely be months with no sales or when there are no ideal properties to flip. In case market conditions go bad, one who is investing for capital gains through flipping, one can be greatly affected as market conditions deteriorate and property values go down. One may not be able to sell the property at all.

5. You are actually selling your time, instead of investing in real estate – One drawback is you really have to put in a lot of time and effort into this type of income. I can’t help but say that this sounds like you are back in the rat race.

6. You let go of a property and its fruits – When you flip properties, you let go of the potential cashflow it can generate, along with any appreciation that the property may have as the years go by. How many times have you heard other seasoned investors say that they regret selling a property because of the excellent rental income they could have had up to now, along with the appreciation of the property ? In a way, all the effort in finding a good deal goes to waste.

Is earned income through real estate for you?

I guess it depends on one’s answer to the question “Why are you getting into real estate investing?”

Is it for quick cash? Do you want to get rich quick? Or is it for financial freedom?

Either way, I suppose this is meant to replace the income you would get from a regular 9 to 5 job and right?!

To illustrate, let’s just say your target income is Php100,000 per month. Lets run the numbers and see how we can achieve this through flipping or through commissions.

How many deals would it take to make Php100K per month through flipping?

In my opinion, a wholesale deal worth pursuing should at least make a net profit of 100K so this means you need to complete a deal at least once a month. Again taxes must be considered, the Php100,000 should already be net of all applicable taxes.

If your profit will be taxed at a rate of 32%, then your gross profit should be at least Php100,000/(1-0.32) = Php147,058.82

For retailing, which usually takes 3 months to complete on the average, a decent target would be to earn at least Php300,000 of net profit. This means your gross profit should be equal to Php300,000/ (1-0.32)= Php441,176.47

Do take note that the above should apply when you are already categorized as someone who is habitually engaged in real estate by the BIR.

Again this is on target for the goal of making at least Php100,000 of net income per month.

But there’s a catch. If we apply the 100-10-3-1 rule where for every 100 deals we analyze, we can expect to have 10 worth inspecting, and 3 are worth making offers, to end up buying one, this means we need to have more than enough leads that would lead to 100 deals worthy of being analyzed and we have to do this each and every month, 12 months a year, or else your income won’t come in. And we haven’t even considered marketing which is needed to sell the properties, which is also very labor intensive.

How many deals would it take to make Php100K per month through commissions?

Let’s say you are a licensed broker and are entitled to a 5% commission for each sale of a property worth less than Php10Million. How much worth of properties do you need to sell just to make Php100,000 per month.

Assuming that you will have to pay income tax at the rate of 32%, then the actual commission one needs to earn would be Php100,000/(1-0.32) = Php147,058.82, similar to the example above for flipping. If this amount represents the 5% commission, then the property should be worth Php147,058.82/0.05 = 2,941,176.47. This means I need to sell about Php2,941,176.47 worth of properties per month just to take home Php100,000 of earned income.

Why does it feel like I’m back in the rat race if I focus on earned income generating activities? Is it just me or are you also beginning to feel that getting earned income through real estate is no different from having a job?!

So much work and taxes to pay and income stops when you stop working

If your goal is financial freedom, then earned income in itself might not be able to provide this mainly because of the amount of work to be done, the huge amount of taxes to pay, and the income stops once you stop working actively, unless you find a better way…

My thoughts on earned income

Earned income is okay if it will eventually be used to buy passive income generating assets. Earned income through flipping properties is great for the short term. The long term goal is to use these earnings to eventually buy properties that generate passive income.

I also believe it would be a good source of supplemental income as opportunities arise, where significant and quick profits are hard to ignore. Supplemental in the sense that it can supplement our income while we ultimately build our passive income streams.

Earned income generating activities as explained above like flipping through wholesaling/retailing and earning through commissions are okay if they can be turned into a business where you are the business owner. When I say business owner, I mean the business can thrive even without you. If a business can’t survive without you, then you own a job, not a business, as paraphrased from Michael Gerber’s book “The E-Myth Revisited”.

Let me try to explain these further in the next part of this series.

Coming up next: Passive income – the path to financial freedom

Coming up in the third part of this series, I’m going to tackle how one can build passive income streams through real estate investing, which I believe is the path to financial freedom.

Passive income through real estate investing – the path to financial freedom (Part 1)

To our success and financial freedom!

Jay Castillo

Real Estate Investor
Real Estate Broker License #: 20056
Blog: http://www.foreclosurephilippines.com
Mobile phone (Call/SMS): +639178843882
Follow me in Twitter:http://twitter.com/jay_castillo
Find us in Facebook:Foreclosure Philippines facebook page

Text by Jay Castillo and Cherry Castillo. Copyright © 2010 All rights reserved.

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Earned income through real estate investing is a post from: Foreclosure Investing Philippines

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A post by Cherry Castillo

I can see that the BIR is dead serious in collecting revenues for the government and is exploring all avenues where tax collection can be improved. In fact, the BIR has a string of recent issuances all concentrating on real property valuation, specifically on updating zonal values to be at par with current market values.

Just to refresh your memory, the basis for the power of the Commissioner of Internal Revenue (CIR) to determine the fair market value (FMV) of properties is Section 6(E) of the Tax Code, which provides:

“(E)  Authority of the Commissioner to Prescribe Real Property Values. — The Commissioner is hereby authorized to divide the Philippines into different zones or areas and shall, upon consultation with competent appraisers both from the private and public sectors, determine the fair market value of real properties located in each zone or area. For purposes of computing any internal revenue tax, the value of the property shall be, whichever is the higher of:

(1)    the fair market value as determined by the Commissioner; or

(2)    the fair market value as shown in the schedule of values of the Provincial and City Assessors.”

The zonal values can be accessed at http://www.bir.gov.ph/zonalvalues/zonalvalues.htm

It is common knowledge, however, that zonal values are not regularly updated and are usually below market value. And since taxes such as the capital gains tax (CGT) are based on the higher amount between the selling price and the actual market value, which is defined as the zonal value, parties sometimes indicate the selling price as just the same or within the vicinity of the zonal value, resulting in a lower CGT. For more information on CGT, please refer to this article about capital gains tax.

Let me give you a run-down of the latest BIR issuances so that you have an idea of things to come:

1. Revenue Memorandum Circular (RMC) No. 071-09 dated December 16, 2009

The officials of the BIR, the Bureau of Local Government Finance (BLGF), and the Philippine Association of Local Treasurers and Assessors, Inc. (PHALTRA) signed a Memorandum of Agreement (MOA) which was circularized in RMC No. 071-09 which states in part that they will share information with each other. Notably, the PHALTRA will improve its cooperation and coordination with the BIR in updating zonal values of real properties. Click here for a copy of RMC No. 071-09.

2. RMC No. 27-2010 dated March 17, 2010

This RMC circularizes the full text of Department Order No. 6-2010 dated March 12, 2010 which was issued by the Department of Finance. In essence, it creates committees on real property valuation that would determine the zonal values of real properties for purposes of computing internal revenue taxes. Real property appraisers in the Philippines have thus become even more valuable. Click here for a copy of RMC No. 27-2010.

3. RMC No. 34-2010 dated April 22, 2010

This RMC publishes the full text of the MOA between the BIR and Creba Land Services and Title Warranty Corporation (Creba Land). Creba Land has a Geographic Information System (GIS) which the BIR will use in relation to its land valuation duties. The BIR will be testing the system first and is required to purchase a license within sixty days from first use. The BIR will initially get a copy of Creba Land’s spatial database for Quezon City, Pasig City, and Taguig City. Click here for a copy of RMC No. 34-2010.

The first Whereas clause in the MOA is most interesting: “xxx the BIR aims to complete the revision of zonal values nationwide by 30 June 2010 xxx”. Personally, I think this is a very tight schedule. Those who have properties in Quezon City, Pasig City, and Taguig City should brace themselves for an increase in taxes (particularly CGT). Please note that real property taxes (RPT) are not paid to the BIR but to the local government unit (LGU). However, as earlier discussed, the BIR has a MOA with the BLGF and PHALTRA so the zonal values project will have an effect on RPT as well. [I can imagine my husband bugging me about my RPT article which has been pending for so long.]

With regard to Creba Land, I have seen several newspaper articles featuring it and its mapping services. If you want to learn more about it, please see https://www.mapsys.ph. I have not inquired with Creba Land but my guess is that it’s very expensive (if they would be willing to let us checkout the system, that would be great!). I read about it and I thought that the investment is too big to be undertaken by a private company. Of course the site owner is intelligent so he got the government to buy his services (nothing bad about that). The idea is good but I think if there is a government agency who will purchase Creba Land’s services it should be the Registry of Deeds and not the BIR. If my understanding is correct, the main purpose of mapsys is to detect title fraud, so I don’t think this is up the BIR’s alley.

On another note, I wonder how much the BIR is going to pay Creba Land for this? Also, if the fees are high, how will this affect the fees that the BIR will charge for the issuance of the Certificate Authorizing Registration (CAR) and Tax Clearance? If there will be no additional fees, will the BIR require that the taxpayer make use of the services of Creba Land? Someone has to pay for this. I hope the BIR can shed more light on this contract.

4. RMC No. 40-2010 dated April 22, 2010

This RMC is about the policies and guidelines in the recruitment and designation of private appraiser members to the Regional Executive and Technical Committees on real property valuation. Click here for a copy of RMC No. 40-2010.

To summarize, the BIR is taking steps to update the Schedule of Zonal Values and we should all be prepared for their eventual increase. Be on the lookout for the schedule of hearings on the proposed revised schedule so you can give your inputs. If you have bought real property and have not yet executed a Deed of Absolute Sale (DOAS), there is a possibility that by the time you execute it, the zonal values have already increased, possibly resulting in increased tax payable. This may potentially impact your projected profits and turn them into losses (ouch!) so it’s good to be prepared, and this goes out to all real estate investors out there!

Cherry Castillo

Cherry is my wife. She is a certified public accountant (CPA) and lawyer.

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To our success and financial freedom!

Jay Castillo

Real Estate Investor

Real Estate Broker License #: 20056
Blog: http://www.foreclosurephilippines.com
Mobile phone (Call/SMS): +639178843882
Follow me in twitter:http://twitter.com/jay_castillo
Like this in Facebook:Foreclosure Philippines facebook page

Text by Jay and Cherry Castillo. Copyright © 2010 All rights reserved.

PS. Are you a new visitor? Click here NOW to start learning more about foreclosure investing in the Philippines and don’t forget to subscribe to e-mail alerts and get notified of new listings of bank foreclosed properties, public auction schedules, and real estate investing tips. Inbox getting full? Subscribe through my RSS Feed instead!

PPS.Do you know anyone who is either an investor or a home buyer looking for a property? Please refer them to our Buy a property form to enter their property requirements. If you need to sell a property fast, please use our Sell a property form to enter details of the property you are selling. If it fits our needs, we just might buy it. Lastly, if know anyone who wants to make 10-15% return on their money, refer them through our Investors’ form. Thanks a million!

Recent BIR Issuances on Property Valuation may affect real estate investors is a post from: Foreclosure Investing Philippines

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My wife who has become so obsessed with finding a new house we can call our home shares updates on what we are thinking of doing with our old house that was devastated by Ondoy, what things to consider, our target locations, finding not just a house but also a sound real estate investment by searching foreclosed property listings, and applicable tax exemptions and pending articles about this and other taxes that apply to real estate, which I hope she finishes soon…

I’m just glad that I was able to convince her to buy a property the way true real estate investors looks for a good deal. Knowing how stubborn she is, I was surprised how easy it was for me to convince her that this is a perfect opportunity for us (as a team) to find a really sound real estate investment that will produce a good positive cashflow if we decide to have it rented out, or sell it for a significant profit down the road. This can only happen if we buy a house well below market value and apply Rich Dad’s principle “… You make money when you buy, not when you sell” as often mentioned by Robert Kiyosaki, best selling author of “Rich Dad Poor Dad”.

Our journey to our new house

By Cherry Castillo

As most of you may already know, we are looking for a new house, as our old house was totally devastated by Ondoy. I am sure many of you are in the same boat as ours. Of course, our decision to move entails more decisions with regard to the next steps, such as:

1. What do we do with our old house? Right now, we have a payment holiday until January 15 with Pag-Ibig. But after that date, we have to continue paying the monthly amortizations. Admittedly, the market value of the house is in question, and it’s not practical to continue paying the amortizations which was based on the market value of Provident Village prior to Ondoy. The next question is, do we sell it now, do we let Pag-Ibig foreclose it, or do we surrender it through a dacion en pago (a.k.a. payment in kind – that is, we give the house as payment for the loan)? If we sell it now, we will be selling it at a loss, but we will be cutting our losses since we will stop paying the high monthly amortization. If we let Pag-Ibig foreclose it (or if we surrender it through dacion en pago), how do we go about it? While it is clear that my husband will no longer be able to take out another housing loan from Pag-Ibig, would it also affect my husband’s credit rating and prevent him from taking out a loan from banks?

2. Granted that we will be moving, where do we go? We can  go anywhere! Anywhere where there’s no flood of course. And since we are now so paranoid of natural (and man-made) calamities, if we are to move, we have to make sure that the area is one that was not reached by floods and that there is at least a second floor.  I don’t want to be in the mountainside too for fear of landslides. We are now open to condominiums (unlike before, when I really could not imagine living in one), but not those that are too high, as I am also concerned about earthquakes. You may have noticed that there have been a lot of news about earthquakes in the Asian region and in the Philippines in particular. I have been telling my officemates that the best place to be is in a low-rise condominium, somewhere in the 3^rd or 4^th floor, since it will not be reached by floods, the structure will be strong enough to withstand earthquakes, and if there’s a fire I can jump out of the window and just have broken bones, or, if there’s a swimming pool nearby, I can just go straight to it. I know it’s a bit on the psycho side but you really get to think a lot about these things if you’ve gone through the great flood brought about by Ondoy. Oh, I forgot, I don’t know how to swim. I better join my son in his swimming lessons this summer! And time to turn into reality the Ondoy-related ideas I have thought about.

3. Where are our target locations? I have narrowed down our choices to the elevated portions of Kapitolyo, Pasig, San Juan, and Quezon City near UP. Aside from the earlier-mentioned considerations, it is very important for us to be near to a good co-ed school for our son as he will be turning five in January 2010 already and it won’t be long before he enters elementary school. I have sort-of developed loyalty to Mother Goose  Playskool and Grade School (This is my son’s school in Provident Village, Marikina which was also devastated by Ondoy. Because they have several branches, they allowed my son to finish the rest of the school year in their Makati branch. Mabuhay ang Mother Goose!) so I want to find a house near a Mother Goose branch. As for my work, I am currently working in Makati but I am open to moving to Ortigas or QC, or maybe if my husband’s business picks up, I might just help him in the business. One of the best lessons I learned in the past years is that TIME is the most precious commodity. There are only 24 hours in a day and spending it on the road is totally useless. So the house should be near the place of work and study. In the course of my research, I have learned that prices are really so steep in the good areas.

4. This of course led me to search our site for foreclosed property listings (In the right side of the this page, you can use the “search” function to look for listings in this site.) I have also called several banks so I have updated listings with me, which my husband will be posting soon. I have also revisited my husband’s post on the Ultimate List of Bank Websites and I have found some updated listings there too. I have found a lot of promising properties and I must admit that it’s really exciting looking for good buys. I have been a bit depressed since last week, after I visited our old house and saw its sorry state. I determined that the only way for me to get out of depression is to finally have a new house! I have been joking that leaving our house is like breaking up with a boyfriend of 5 years – the only way to have closure is to have a new house/boyfriend! The process of looking for and deciding on the perfect place to grow our roots is both tiring and exciting. I do hope we find the house meant for us soon. We have visited a foreclosed property in Mandaluyong last week, full of excitement, only to have our bubble burst because of the really bad neighborhood, one of the worst as my husband put it (And he grew up in Mandaluyong! I really don’t understand why the Mandaluyong local government spends so much money fixing the islands  when they have so many squatters!).  My husband reminded me that it should be the other way around – we should find the worst looking house in a good neighborhood. I have also selected several properties and when I called up the bank, I discovered that they either have pending cases or encumbrances, or the bank does not have possession. Hay! I guess we have to look at more foreclosed properties (Around 100 more according to my husband – that’s a lot!). In God’s time, I know we will find the one for us.

5. Applicable taxes and tax exemptions? Being the tax person that I am, I really have to consider taking advantage of the  capital gains tax (CGT) exemption from the sale of principal residence. I also need to create a post about this and all the other taxes – real property tax (RPT), percentage taxes, VAT, etc. (Okay, I’m really delinquent I admit!).

So basically, we will be going through the entire process of choosing a property that will also be a good investment. We are also looking at other properties, though not foreclosed but are rather houses for sale by owner (FSBO), but which look like good deals. We will do our best to document each step of the way so that it can be a handy and useful guide for everybody, much like a walk-through of the process. Wish us luck!

Cherry is my wife. She is a certified public accountant (CPA) and lawyer.

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My vision – financial freedom for all!

Jay Castillo
Real Estate Investor
Real Estate Broker License #: 20056
Blog: http://www.foreclosurephilippines.com
Click here to contact me via E-mail
Mobile phone (Call/SMS): +639178843882
Twitter: http://twitter.com/jay_castillo
Facebook: Foreclosure Philippines fan page

Text by Jay Castillo. Copyright © 2009 All rights reserved.

PS. If you are a new visitor, please start here to learn more about foreclosure investing in the Philippines.

PS2. Larry Gamboa and Bo Sanchez will give the Think Rich Pinoy Seminar this November 21 at the Philamlife Building in UN avenue in Manila. Larry will discuss his unique Real Estate methods, buying foreclosed properties and turning them around for passive income. You’ll also get to play Robert Kiyosaki’s CashFlow 101 Game and learn! To attend, click here now!

PS3. If you feel that anyone else you know might benefit from this post, please do share this to them and don’t forget to subscribe to e-mail alerts and get notified of new listings of bank foreclosed properties, public auction schedules, and real estate investing tips. If your inbox is getting full, you may subscribe through my RSS Feed instead.

Our journey to our new house – Finding a new home like true real estate investors is a post from: Foreclosure Investing Philippines

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“In this world nothing is certain but death and taxes.” – Benjamin Franklin

Taxes are indeed inescapable and the real estate industry is no exception. I am sure a lot of real estate investors are very much interested to know the taxes involved in investing as they significantly impact the total cost of acquiring a property.

What may seem like a good deal may turn out to be a bad one, if all the taxes are factored in. So before you go ahead and plunge into the world of real estate investing, I suggest you take the time to study taxes. For this post, I will be discussing capital gains tax on real estate.

I’ll try to discuss capital gains tax on real estate in layman’s terms, based on what I have learned, for purposes of information-sharing. A disclaimer is in order of course: While great effort has been taken to ensure the accuracy of the discussion here as of its writing, this is not intended to replace seeking professional services. Do read up on the relevant laws and regulations also.

Capital Gains Tax vs. Income Tax

When there is a sale of real estate, automatically people think that they have to pay Capital Gains Tax (CGT). This is not necessarily the case. CGT is a tax on the gain from the sale of capital assets. Regular corporate income tax (RCIT) [for corporations] and regular income tax [for individuals] apply to the sale of ordinary assets while CGT applies to the sale of capital assets.

Thus, we first have to determine whether the asset being sold is a capital or an ordinary asset so as to know the proper tax rate to be used and the BIR form to be used, among others.

Capital assets vs. Ordinary assets

The term “capital assets” is defined negatively in Section 39(A)(1) of the Tax Code as follows:

“(1) Capital Assets. – the term ‘capital assets’ means property held by the taxpayer (whether or not connected with his trade or business), but does not include

• stock in trade of the taxpayer or other 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
• property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or
• property used in the trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34;
• or real property used in trade or business of the taxpayer.”

As applied to the real estate industry, the terms “capital assets” and “ordinary assets” are defined in Section 2(c) of Revenue Regulations (RR) No. 7-2003 dated December 27, 2002. It’s essentially the same as the above definition.

It has an additional provision, though, on real properties acquired by banks through foreclosure sales – the same are considered as their ordinary assets but banks shall not be considered as habitually engaged in the real estate business for purposes of determining the applicable rate of expanded withholding tax.

Since we are talking about the sale of real property here, we need to know the definition of “real property”. Section 2(c) of RR No. 7-2003 states that “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.” Article 415 of the Civil Code provides:

“Art. 415. 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.”

Thus, it appears that it is not only the sale of land and buildings or houses which we should be focusing on, but also the sale of the above.

As RR No. 7-2003 is a very important rule on real estate, I have included the said regulations in this post for your reference. Read it in its entirety. You may download a copy here. Answers to frequently asked questions can be found in this document.

In simple terms, if the property is not ordinarily held for sale (as inventory) or used in business and subject to depreciation, then the property is a capital asset. Now, if a seller is engaged in the real estate business, and the property is one he holds out for sale to the public, then the property may be considered as an ordinary asset.

[Note that there may be instances when a seller is engaged in the real estate business but the property is not held for sale or used in business or was idle for a long time – this is one of the instances when the property may be considered a capital asset.]

Conversely, if a seller is not engaged in the real estate business, and the property is not used in business and subject to depreciation, the property may be considered as a capital asset, the sale of which is subject to CGT.

Section 3 of RR No. 7-2003 provides the Guidelines in Determining Whether a Particular Real Property is a Capital Asset or Ordinary Asset.

Tax Rate to be Used

When the real property which is a capital asset to the seller is sold, the gross selling price or fair market value (FMV) [zonal value], whichever is higher, will be subject to 6% CGT. Please refer to the BIR website http://www.bir.gov.ph/zonalvalues/zonalvalues.htm for the zonal values.

Technically, it’s not really only the gain (selling price less cost) which is taxed, because even if the seller suffered a loss (that is, the selling price is lower than the original acquisition cost of the property), there will still be CGT, because a gain is always presumed.

On the other hand, if the seller is engaged in the real estate business, and the real property sold is an ordinary asset, the sale will be subject to RCIT [or minimum corporate income tax (MCIT), when applicable] if the taxpayer is a corporation and income tax if the seller is an individual.

The proceeds from the sale of the real property will be included in the seller’s global income (meaning income from all sources – note that domestic corporations and resident citizens are taxed on all sources of income, whether from within or outside the country) and only the net income, after allowable deductions such as depreciation, losses, etc. will be subjected to RCIT, MCIT, or regular income tax, whichever is applicable.

Under Republic Act No. 9337, the RCIT is now 30% on net taxable income (beginning on January 1, 2009, down from 35%). The regular income tax for individuals remains at 32%.

Please note that there is an exception to the application of the CGT, and that is the sale of a principal residence (your own home). This deserves a separate discussion as I intend to take advantage of this when we purchase our next residence.

BIR procedure

Assuming that you are interested in buying a property from a seller who is an individual and who is not engaged in the real estate business, the seller needs to pay CGT on the sale of his real property, unless you have made an agreement that you as the buyer will shoulder this.

The seller needs to file BIR Form No. 1706 within thirty (30) days after each sale, exchange, transfer or other disposition of real property. You can download BIR Form No. 1706 here.

Documentary Requirements

1 ) One original copy and one photocopy of the Notarized Deed of Sale or Exchange

2 ) Photocopy of the Transfer Certificate of Title; Original Certificate of Title; or Condominium Certificate of Title

3 ) Certified True Copy of the tax declaration on the lot and/or improvement during nearest time of sale

4 ) “Certificate of No Improvement” issued by the Assessor’s office where the property has no declared improvement, if applicable or Sworn Declaration/Affidavit of No Improvement by at least one (1) of the transferees

5 ) Copy of BIR Ruling for tax exemption confirmed by BIR, if applicable

6 ) Duly approved Tax Debit Memo, if applicable

7 ) “Sworn Declaration of Interest” as prescribed under Revenue Regulations 13-99, if the transaction is tax-exempt

8 ) Documents supporting the exemption

Additional requirements may be requested for presentation during audit of the tax case depending upon existing audit procedures.

How to File the Capital Gains Tax Return

You just have to file the Capital Gains Tax return in triplicate (two copies for the BIR and one copy for the taxpayer) with the Authorized Agent Bank (AAB) in the Revenue District where the property is located, along with the documentary requirements and the tax due.

In places where there are no AAB, the return will be filed directly with the Revenue Collection Officer or Authorized City or Municipal Treasurer. You can view the Revenue District Offices (RDO) here: http://www.bir.gov.ph/directory/rdo.htm. Click on the concerned RDO.

For example, if you click on RDO 48 – West Makati, you will get to http://www.bir.gov.ph/directory/rdoinner.htm#48. The names of the Revenue District Officer and Assistant Revenue District Officer as well as their contact numbers and e-mail addresses, and the address of the Revenue District Office and the AAB’s within the said RDO may be found there.

Sample CGT computation

A residential condominium in Makati City with a floor area of 50sqm has a Selling Price (SP) of 1.0M. The existing zonal value per square meter for that condo in Makati is currently Php50,000/sqm. You have called the owner and found out that he is not engaged in the real estate business.

He also told you that as part of the deal, the buyer shall shoulder the CGT. As the buyer, how much is the CGT which you will have to pay the seller on top of the selling price?

First let’s compute for the Fair market Value (FMV):

FMV=Zonal Value x Floor Area
=50,000 pesos/sqm x 50sqm
=2,500,000 pesos

Since FMV is higher than SP, we shall use FMV to compute the CGT:

CGT=6% x FMV
=0.06 x 2,500,000 pesos
=150,000 pesos

Therefore, the buyer shall have to shell out an additional 150,000 pesos.

Note that while technically, the CGT is always the responsibility of the seller, and that if the buyer shoulders the CGT, it is in effect part of the selling price to be compared to FMV for purposes of computing the 6% CGT, I noted that the practice of banks is to compute the CGT this way.

Now, what if you called up the seller and told him that you are willing to buy the property but he should shoulder the capital gains tax as the seller, then he counters your offer and says he is willing to shoulder the CGT up to his selling price and the buyer shall shoulder the CGT for the excess or the difference between the SP and FMV, how do you compute for the CGT?

First, let’s compute for the excess or difference between the SP and the FMV:

Excess=FMV-SP
=2,500,000pesos – 1,000,000pesos
=1,500,000 pesos

Now, let’s compute for the CGT to be shouldered by the buyer:

CGT for the buyer =6% x Excess
=0.06 x 1,500,000 pesos
=90,000 pesos

The CGT to be shouldered by the seller is as follows:

CGT=6% x SP
=0.06 x 1,000,000 pesos
=60,000 pesos

Take note that the total CGT is 90,000 pesos + 60,000 pesos = 150,000 pesos, which is consistent with our first computation. The CGT was just split between the buyer and the seller.

As investors, we should always try to negotiate for the best terms and in relation to this particular example, always try to have the other party shoulder the CGT.

The seller will still be the one to file the CGT and he shall have to file the return in an Authorized Agent Bank within the Revenue District where the property is located in Makati, within 30 days the deed of sale was executed.

Conclusion

The BIR website (http://www.bir.gov.ph) has a wealth of information on taxes. Refer to it from time to time. The BIR also has a 24-hour contact center (Telephone number 981-8888) and you can call them if you have any questions.

You may also e-mail them at contact_us@cctr.bir.gov.ph. You can also ask me through the comments section and I will do my best to research the answer.

In my next posts, I will be discussing Value-Added Tax (VAT), expanded withholding taxes (EWT) a.k.a. creditable withholding taxes (CWT)**, Real Property Taxes (RPT), Transfer Taxes (TT), CGT on the sale of a principal residence, and estate taxes (as I am sure many of you are also interested in transferring your properties to your heirs in the future – remember, aside from taxes, death is certain too).

Let me know, through the comments section , if you have any other taxes you would like to know about, or if there’s anything you would like to have any clarification on.

In closing, please remember that as an investor, one should always consider the capital gains tax in real estate transactions. Failure to do so could mean your real estate capital gains will just get eaten up by the corresponding capital gains tax and turn what looked like a good deal into a bad one.

Till then, happy investing!

*This article was written with the help of my wife, who happens to be a certified public accountant and a lawyer.

**Sorry Betty, CWT shall have to be covered on the next post. This post is too long already. =)

What is Capital Gains Tax on Real Estate? is a post from: Foreclosure Investing Philippines

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