CALASANZ V. CIR AND CTA (TAX)

Issues:

1. Whether or not petitioners are real estate dealers liable for real estate dealer's fixed tax; and
2. Whether the gains realized from the sale of the lots are taxable in full as ordinary income or capital gains taxable at capital gain rates.

Commissioner maintained that the imposition of the taxes in question is in accordance with law since petitioners are deemed to be in the real estate business for having been involved in a series of real estate transactions pursued for profit. Respondent argued that property acquired by inheritance may be converted from an investment property to a business property if as in the present case, it was subdivided, improved, and subsequently sold and the number, continuity, and frequency of the sales were such as to constitute "doing business." Respondent likewise contended that inherited property is by itself neutral and the fact that the ultimate purpose is to liquidate is of no moment for the important inquiry is what the taxpayer did with the property. Respondent concluded that since the lots are ordinary assets, the profits realized therefrom are ordinary gains, hence, taxable in full.

We agree with respondent Commissioner.

The assets of a taxpayer are classified for income tax purposes into ordinary assets and capital assets. NIRC broadly defines CAPITAL ASSETS as follows:

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,

1. 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;
2. property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
3. property used in the trade or business of a character which is subject to the allowance for depreciation provided in subsection (f) section 30; or
4. real property used in the trade or business of the taxpayer.

The statutory definition of capital assets is negative in nature. If the asset is not among the exceptions, it is capital asset; conversely, assets falling within the exceptions are ordinary assets. And necessarily, any gain resulting from the sale or exchange of an asset is a capital gain or an ordinary gain depending on the kind of asset involved in the transaction.

Also, a property initially classified as a capital asset may thereafter be treated as an ordinary asset if a combination of the factors indubitably tend to show that the activity was in furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inherited real property usually gives capital gain or loss even though the property has to be substantially improved or both to make it saleable. However, if the inherited property is substantially improved or very actively sold or both, it may be treated as held primarily for sale to customers in the ordinary course of the heir's business.

One strong factor against petitioners' contention is the business element of development which is very much in evidence. Petitioners did not sell the land in the condition in which they acquired it. While the land was originally devoted to rice and fruit trees, it was subdivided into small lots and in the process converted into a residential subdivision and given the name Don Mariano Subdivision.

Another distinctive feature of the real estate business discernible from the record is the existence of contract receivables. Also of significance is the circumstance that the lots were advertised for sale to the public and that sales and collection commissions were paid out during the period in question.

In view of the foregoing, the SC holds that in the course of selling the subdivided lots, petitioners engaged in the real estate business and accordingly, the gains from the sale of the lots are ordinary income taxable in full.