THE WORST ADVICE

Once upon a time, a couple owned a house in a posh village and a high-end condo.

They were in that stage where they simply wished to see the world. So, they decided to lease out their house and stay in their condo. They got their trusted broker friend to look for a tenant.

Their friend showed their house multiple times until one day, they got an offer. The prospective tenant was a top executive of a multinational company. Since the company wanted to declare the rent as an expense, they required an official receipt for the rent.

So, the broker advised the couple to register themselves as real estate lessors so they could issue official receipts. And after a month or two, the lease commenced.

A decade passed. The lease ended. And they sold that house they rented out. The same broker-friend sold the house for them.

One day, the couple decided to migrate to another country and sell their condo. They used a different broker this time (Broker 2). It was not long until Broker 2 found a buyer. Broker 2 conducted due diligence in preparation for the sale and discovered that the couple were registered lessors. As such, Broker 2 advised the sellers that the deal would be subjected to VAT and income tax.

The couple couldn't believe what they were told, mainly since they sold their house without paying VAT. They looked down on Broker 2 and thought he didn't know what he was talking about...

According to Broker 2, they risked paying over Php70 Mn in taxes.

I'll end the story here.

So, who's correct?

To be continued in tomorrow's post...

***

Circling back to yesterday's post...

So, who's correct?

a. The sellers thought the previous sale of their house settled the issue. They sold it without VAT, so why should the condo be any different?

b. Broker 2 disagreed and warned them that their potential tax exposure could exceed P70 million.

Q1. Who's right?

Broker 2 had very good reason to raise the alarm.

RR 7-2003 has long been interpreted broadly by the BIR. Registering yourself as a real estate lessor can put even your other properties at risk of being classified as ordinary assets.

And if a property is treated as an ordinary asset, the sale may be subject to ordinary income tax and VAT instead of the 6% capital gains tax normally associated with capital assets.

Q2. So why wasn't their previously rented house subjected to VAT when they sold it?

I don't know. I'd have to see the documents and circumstances of that sale.

But here's the dangerous assumption:

"BIR didn't tax me that way last time, so they can't tax me that way next time."

That's like riding a motorcycle in the bus lane, not getting caught, and concluding that motorcycles must be allowed there.

Q3. Could the couple have structured things differently?

Yes.

There are perfectly LEGAL ways to structure property ownership and leasing more efficiently. That's tax planning, not tax evasion.

But proper structuring also comes with costs, paperwork, and its own tax consequences.

Case-in-Point:

Before registering yourself personally as being engaged in the real estate business, understand what that decision could mean for your other properties when you eventually sell them.