PRINCIPAL RESIDENCE

Q. Mr. X sold his residence for P1,000,000. He acquired this property for
P400,000. Within 18 months thereafter, he utilized P800,000 of the proceeds in
acquiring a new residence. What amount is subject to capital gains tax?

A. The amount of P200,000 which was not utilized for acquiring a new
residence is taxable at 6%.

Section 24(D)(2) exempts gains presumed to have been realized from the
sale or disposition of an individual's principal residence from capital gains tax.
The EXEMPTION CAN ONLY BE AVAILED OF ONCE IN EVERY 10 YEARS. To be
fully entitled to the exemption, the seller must UTILIZE the entire PROCEEDS of
sale IN ACQUIRING OR CONSTRUCTING A NEW PRINCIPAL RESIDENCE
WITHIN EIGHTEEN (18) CALENDAR MONTHS FROM THE DATE OF SALE OR
DISPOSITION. Any portion of the proceeds which is not utilized in acquiring or
constructing a new principal residence will be subject to the capital gains tax.
Section 24(D)(2) prescribes the following formula for computing the taxable
proceeds:

(Unutilized proceeds divided by Gross Selling Price) X whichever is higher of

Gross Selling Price or FMV = Taxable Proceeds

Q. Section 24(D)(2) provides "THAT THE HISTORICAL COST OR

ADJUSTED BASIS OF THE REAL PROPERTY SOLD OR DISPOSED SHALL
BE CARRIED OVER TO THE NEW PRINCIPAL RESIDENCE BUILT OR
ACQUIRED." In other words, the cost or adjusted basis of the property sold is
substituted as the basis of the property acquired when determining the gain (or
loss) upon subsequent sale of the new principal residence.

(a) When is there a need to use "basis" in computing the capital gains
tax upon subsequent sale of a new principal residence?

(b) Assume in Q 1 above that 8 years after Mr. X sold his old
residence, the taxpayer sold the new residence for Pl,200,000 to the
government. If he opts under Section 24(D)(1) of the Tax Code to have the
capital gain taxed under Section 24(A), what will be the amount includible
in his gross income?

(C) Assume in Q1 above that Mr. X sells the new residence to a non-
governmental entity or person, the 6% capital gains tax should be based on what
amount?
A. (a) There is a need to use "basis" in computing the capital gains tax
upon subsequent sale of a new principal residence if the same was: (a)
 2

subsequently sold as a capital asset to the government or any of its political

subdivision or agencies or to government-owned or controlled corporations and
the taxpayer-seller avails of the option to include the gain from the sale thereof
with other taxable incomes subject to the graduated rates, or (b) converted into
an ordinary asset and subsequently sold as such, in either of which case the
"substituted basis" will be used in determining the taxable gain.

(b) If the taxation of an unutilized portion of the proceeds of sale was not
deferred but has already been subjected to capital gains, such portion should not
be subject to double taxation upon subsequent sale of the new principal
residence. This can be accomplished by adding such unutilized portion of the
selling price to the substituted basis to arrive at a "stepped-up basis". By using a
stepped-up basis, the capital gain (presumed to have been realized from the un-
utilized portion of the proceeds of sale) which has already been subjected to tax
upon prior sale of the old residence will not be subject again to tax upon
subsequent sale of the new principal residence. Thus, the amount includible in
his gross income will be determined as follows:

Selling price …………………………………. P1,200,000

Less adjusted basis:
Historical cost of old residence.... P400,000
Add un-utilized proceeds already
taxed ………………. 200,000
Stepped-up (adjusted) basis …………………… - 600,000
Long-term capital gains ……………………… P 600,000
Amount includible in gross income:
50% (the property was held for
more than 12 months)(Sec. 39(B)(2)……... P 300,000

The requirement to carry-over the historical cost or adjusted basis of the

old residence to the new principal residence indicates a legislative intention to
prevent double taxation of the unutilized portion (or of the capital gain
presumed to have been realized from such unutilized portion) which was
previously taxed. This could be achieved, not by using a substituted basis but
simply by deducting the amount of the unutilized portion of the proceeds of sale
of the old residence from the sales proceeds of the new principal residence.

(c) If Mr. X sells the new residence to a non-governmental entity or

person, the 6% capital gains tax should be based on Pl,000,000 computed as
follows:

Selling price of new residence …………………. P l,200,000

Less unutilized portion of selling price
of old residence ………………………… - 200,000
 3

Amount subject to 6% capital gains tax …….. P1,000,000

The capital gain which is presumed to have been realized forms part of
the entire selling price of Pl,200,000. Such capital gain consists of a tax exempt 1
portion of the proceeds utilized in acquiring the new residence and the
unutilized portion of the proceeds which have already been taxed. Double taxation
of the gain presumed to have been realized out of the unutilized proceeds will be
avoided by deducting the amount of such proceeds from the total selling price of
the new principal residence. Thus, in this case, only the capital gain presumed to
have been realized out of the utilized (but previously untaxed) proceeds will be
taxed.

1
Actually the taxation of such portion is deferred since the law requires the use of a substituted basis (original or
adjusted) basis of the old residence as the basis of the new principal residence. It is not exempt; rather it is not recognized in
the year of sale.