CONVERSION TO NON-VAT

During my CPD seminar over the weekend, the lecturer gave advice that wasn’t entirely accurate, so I’m addressing it here.

An attendee asked: How can a rental property sale avoid VAT?

The lecturer suggested closing the lessor's BIR registration as a lessor and leaving the property idle for two years. However, this advice overlooks a key detail in BIR Revenue Regulation (RR) No. 7-2003, Section 3.e.

This section states that ordinary assets are automatically converted into capital assets if they have not been used in business for more than two years. However, there’s a crucial detail that was overlooked: for this conversion to apply, the owner must NOT be engaged in the real estate business.

Example (Where VAT Does NOT Apply):

A manufacturing company shuts down in 2006, leaving land idle. Since the business was never in real estate, the property converts to a capital asset, making the sale VAT-exempt.

Why This Doesn’t Work for Rental Properties:

If a property was rented out, the owner is considered ENGAGED IN REAL ESTATE. Even after two years of inactivity, the property remains an ordinary asset, making its sale subject to VAT.

RR 7-2003 states:

"In the case of subsequent non-operation by taxpayers originally registered to be engaged in the real estate business, all real properties originally acquired by it shall continue to be treated as ordinary assets."

Why Some Rental Property Sales Avoid VAT

Some may argue that they’ve successfully paid only Capital Gains Tax (CGT) instead of VAT. This likely happened because the BIR failed to establish that the property was previously rented out or used for business.

Here’s how the BIR typically verifies rental activity:

For individuals: TIN classification, Certificate of Non-Tenancy, ocular inspection (this is why some demolish structures before selling), tenant reports withholding tax on rent payment.

For businesses: Financial records, depreciating assets, rental receipts, etc.

Bottom Line

The 2-year-idle rule does NOT apply to rental properties, and using it to argue against VAT won’t hold up in a tax audit.