G.R. No. L-24248 July 31, 1974
ANTONIO TUASON, JR., petitioner, vs. JOSE B. LINGAD, as Commissioner of Internal Revenue, respondent.

FACTS

Petitioner Antonio Tuason, Jr. inherited two contiguous parcels of land in Manila from his mother in 1948. Prior to her death, his mother had subdivided the property into 29 lots. Twenty-eight of these lots were under lease agreements with occupants, which were set to expire on December 31, 1953. The 29th lot, a large, low-lying parcel, was unoccupied and used for planting crops. After taking possession in 1950, Tuason instructed his attorney-in-fact to sell the properties. The 28 occupied lots were sold to their occupants on installment. Lot 29 required filling and development; after being filled, subdivided, and provided with roads, its resulting small lots were also sold on installment over several years.
For the years 1953, 1954, and 1957, Tuason reported the gains from these sales as long-term capital gains, paying tax on only 50% of the profit. The Bureau of Internal Revenue initially approved this treatment. However, in 1963, the Commissioner reversed this position, issuing a deficiency assessment that treated the gains as ordinary income, subject to full taxation. The Court of Tax Appeals upheld the Commissioner’s assessment.

ISSUE

Whether the gains realized by the petitioner from the sale of the subdivided residential lots are taxable as ordinary income or as capital gains.

RULING

The Supreme Court ruled that the gains are ordinary income, not capital gains. The legal logic hinges on the statutory definition of “capital assets” under the National Internal Revenue Code, which excludes “real property used in the trade or business of the taxpayer.” The Court found that the inherited properties were not merely passive investments held for capital appreciation. Crucially, the petitioner was engaged in the business of leasing real estate. The 28 lots were generating rental income from tenants at the time of inheritance and until their leases expired. This established that the properties were “used in the trade or business” of leasing, a commercial activity. The act of subdividing the large Lot 29, improving it with fill and roads, and systematically selling the resulting plots over a period further demonstrated a purpose to sell property to customers in the ordinary course, which is another statutory exclusion from capital asset treatment. The Court rejected the petitioner’s arguments that he was not the original lessor and that the leases were pre-existing, holding that upon inheritance, he stepped into the shoes of his mother and continued the business of holding the properties for rental income. Consequently, the properties lost their status as capital assets, and the profits from their sale were correctly taxed as ordinary income. The deficiency assessment was affirmed.