Written by Ian B. Lapinid, 8 November 2007
To many of us, death is something we would rather not discuss.
But whether we like it or not, it is a reality that we will all be facing at some point in our life. Death of a family member or loved one would always bring pain, sadness and sorrow on the family.
However, for those who die with properties, another important consequence of death is tax, a consequence which often times family members who are left behind are not prepared to face.
Yes, in this situation, death and taxes are inevitable. That, for me, is what undas is, from a tax perspective. A cliché, to be sure; but the truth is that, even when you die, you will be taxed.
Given these inevitable realities, I thought it fitting as we celebrate the yearly undas to discuss the tax consequence of death to give our readers a better understanding of this topic.
When someone dies ("decedent"), our tax laws impose an estate tax on the net value of the property ("estate") of the decedent at the graduated rates of 5% to 20% (20% applies for P10 million up).
The value of the real property is based on the fair market value (FMV), which, in turn, is based on the zonal valuation of the property as determined by the Bureau of Internal Revenue (BIR). For personal properties, the estate tax is based on the FMV of the properties at the time of death.
Payment of the estate tax is important not only because it is imposed by law but because, generally, there can be no disposition or distribution of the properties of the decedent unless the estate tax has been paid.
Often times, however, the heirs are not prepared to pay the estate tax. Under the Tax Code, the heirs are allowed to withdraw just a measly sum of twenty thousand pesos (P20,000.00) from the bank account of the decedent upon prior approval by the Commissioner of Internal Revenue (CIR) even without the tax clearance to help the heirs defray the funeral expenses and other related expenses including the estate tax.
You would all agree that the estate tax cannot be paid out of the P20,000.00 as this amount is not even enough to give us a decent burial given the present standard prices of goods and services.
Thus, in such instances, the heirs are forced to look for potential buyers of a portion, if not the whole, of the inherited property to generate the cash needed to pay off the estate tax due. Quite a number of BIR rulings have already been issued wherein the heirs of the decedent were granted provisional authority by the CIR to sell some properties of the decedent for the purpose of raising the funds for the payment of estate tax.
Unwelcome surprises such as the estate tax, though, can be avoided or better yet managed, through proper tax planning before death. Various schemes are adopted to save on the estate tax. Donation or sale of properties to the heirs prior to death may be practical schemes if we are talking only of one or few real properties with small values.
However, if the transaction would involve real property/ies of substantial amount/s, a tax-free exchange (TFE) transaction under Section 40(C)(2) of the Tax Code would seem to be a preferred option.
Generally, a TFE transaction involves the transfer by the owner of his/her property/ies to a corporation (usually a real property holding company which the owner shall establish) in exchange for shares of stock in that corporation, and as a result of the exchange, said person acquires control over said corporation.
It is referred to as tax-free because the transferor shall not be subject to tax on the gain realized from the transaction at the time of transfer.
However, the transfer is not absolutely tax-free, since the tax effect of said transaction is merely deferred so that upon the subsequent sale, disposition or transfer of the property/ies or shares exchanged, the gain or loss from such transaction shall be recognized based in general, on the original acquisition cost of the transferor.
The owner in this case does not really lose ownership of his/her real property/ies. He/She still owns the property/ies indirectly through the shares of stocks in the real property corporation that will be issued to him of which he/she is the direct owner.
Upon the owner’s death, what the heirs will inherit will be the shares of stocks in the real property corporation. Thus, the property subject to estate tax would no longer be the real property/ies but the shares of stocks in the real property corporation based on their book value, which is generally the original acquisition cost of the real property/ies subject of the exchange.
Effectively, therefore, the estate tax saving would consist in the estate tax that would have been applied on the difference between the fair market value or zonal value, whichever is higher, of the real property/ies and its/their acquisition cost, had the inheritance consisted of the real property/ies instead of shares of stocks.
A TFE, though, requires the prior confirmation of the Bureau of Internal Revenue.
Without such ruling, the transfer shall be deemed a regular transfer and, as such, transfer of title to the real property in the name of the transferee (corporation) cannot be effected unless payment of the income tax due on the gain realized from the transfer is made.
Notwithstanding this administrative requirement, I believe a TFE could still be a practical option that can be explored especially so if the real property/ies involved was/were acquired many years ago and is/are therefore presumed to have low acquisition cost.
Moreover, a TFE is simpler compared to a transfer of real property which would require the securing of a new Transfer Certificate of Title from the Register of Deeds and a partition of the inherited real property/ies among the heirs which is more tedious and costly.
