Capital Asset vs Ordinary Asset

Capital Asset vs. Ordinary asset

One of the frequent concerns of a taxpayer who disposes or transfers his property is the resulting tax

consequences. Proper classification of the property to be disposed of or transferred is imperative in order

to determine the correct applicable tax. A question which must be first addressed is whether it is a capital

asset or ordinary asset.

Section 39 of the Tax Code defines the term “capital assets” by the process of exclusion. The term

“capital assets” means property held by the taxpayer (whether or not connected with his trade or

business), but does not include the following: 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; property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or

business; property used in the trade or business, of a character which is subject to the allowance for

depreciation ; and real property used in trade or business of the taxpayer.

From the foregoing, capital assets are generally properties that are not used in trade or business of the

taxpayer. On the other hand, ordinary assets are properties used in trade or business or primarily held for

sale by the taxpayer.

The sale of capital assets (land and/ or building) is subject to capital gains tax at the rate of six percent

based on the gross selling price or fair market value at the time of sale, whichever is higher and the

corresponding documentary stamp tax (DST). Conversely, sale of ordinary assets is subject to the

creditable withholding tax at a rate ranging from 1.5 percent- 6 percent and consequently to ordinary

income tax, corresponding DST and likewise to the 12 percent VAT.

Nevertheless, one vital point which must also be considered is the conversion of the classification of the

properties. Take for instance, if a taxpayer suffering from financial distress decides to cease its business

operations leaving its properties formerly used in business as idle and abandoned. If those properties

were subsequently disposed of, what would then be the classification? Would they maintain their

classification as ordinary assets? Or will they be converted into capital assets?

Section 3(4) (e) of Revenue Regulations (RR) No. 07-2003 provides for the guidelines in determining

whether a particular real property is a capital asset or an ordinary asset. It provides that 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 nonetheless continue to be treated as ordinary

assets. Real property initially acquired by a taxpayer engaged in real estate business shall not result in its

conversion into a capital asset even if the same is subsequently abandoned or becomes idle. However,

properties classified as ordinary assets for being used in business by a taxpayer engaged in the business

other than real estate 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.

Ordinary Tax vs. Final Tax

Section 24. Income Tax Rates.

(A) Rates of Income Tax on Individual Citizen and Individual Resident Alien of the Philippines.

(1) An income tax is hereby imposed:

(a) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within and without the Philippines be every individual citizen of the Philippines residing therein;

(b) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (B), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual citizen of the Philippines who is residing outside of the Philippines including overseas contract workers referred to in Subsection(C) of Section 23 hereof; and

(c) On the taxable income defined in Section 31 of this Code, other than income subject to tax under Subsections (b), (C) and (D) of this Section, derived for each taxable year from all sources within the Philippines by an individual alien who is a resident of the Philippines.

The tax shall be computed in accordance with and at the rates established in the following schedule:

Not over P10,000……………………… 5%

Over P10,000 but not over P30,000…… P500+10% of the excess over P10,000

Over P30,000 but not over P70,000…… P2,500+15% of the excess over P30,000

Over P70,000 but not over P140,000… P8,500+20% of the excess over P70,000



Over P500,000 …………………………… P125,000+34% of the excess over P500,000 in 1998.

Provided, That effective January 1, 1999, the top marginal rate shall be thirty-three percent (33%) and effective January 1, 2000, the said rate shall be thirty-two percent (32%).

For married individuals, the husband and wife, subject to the provision of Section 51 (D) hereof, shall compute separately their individual income tax based on their respective total taxable income: Provided, That if any income cannot be definitely attributed to or identified as income exclusively earned or realized by either of the spouses, the same shall be divided equally between the spouses for the purpose of determining their respective taxable income.

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Capital Asset vs Ordinary Asset