Tax on Real Estate Capital Gains in Ecuador

1. Background, Immediate Benefit for Mining Companies, and Impact on the Construction Sector

The Organic Law to Prevent Speculation on Land Value and Tax Assessment, through which the so-called real estate capital gains tax was created, was published in Official Register No. 913, Seventh Supplement, on December 30, 2016.

However, it was not limited to regulating matters related to “speculation on land value”; it also granted tax benefits to mining companies with exploitation contracts.

Indeed, the First Amending Provision, which amended Article 165 of the Reform Law for Tax Equity, extended the deadline for mining companies to pay extraordinary profits from one month to forty-eight months after the relevant month.

This benefit was immediate. Therefore, in substance, this benefit — and no other — was among the true motivations behind the Law.

Although, in the real estate sector, its impact was not immediate because the new tax applied from the second sale onward, the construction sector, already affected by the recession, was hit by a drop in demand due to the negative expectations generated by the legal framework.

2. Taxable Event of the Tax on the Speculative Value of Land, the Second Transfer, and Vacant Lots

Article 561 of the COOTAD was amended to tax the transfer of rural or urban real estate which, under any title, gives rise to an extraordinary gain.

Transfers by inheritance due to death, donations, raffles, lotteries, auctions or judicial sales, adjudications of marital partnership assets, and distribution of commercial company assets are excluded.

Transfers made by the State, payments in kind for debts, and transfers carried out by real estate developers and construction companies in social-interest housing projects are exempt.

In the case of contributions to companies, only those made to trusts or companies whose ultimate purpose is real estate development or the construction of properties for commercialization are taxed.

The First Transitional Provision clarifies that the new tax shall apply from the second transfer onward.

It is established that the capital gains tax, provided in the COOTAD since its approval and previously in the Municipal Regime Law, “shall tax up to the first transfer of assets acquired prior to the enactment of the law,” or until 2021 in the case of vacant lots — meaning urban or urban expansion land with buildings covering less than 10% of the surface area.

Vacant lots contributed to trusts or real estate and construction companies are excluded from this transitional benefit until 2021.

Until the second transfer, rural properties do not pay either of the two taxes: the capital gains tax or the extraordinary gains tax.

3. Ordinary Gain

Acquisition Value and Adjustment Factor

Ordinary gain is the result of multiplying the acquisition value of the real estate property — the value stated in the public deed, plus the value of improvements, plus payments of special improvement contributions — by the ordinary gain adjustment factor.

This adjustment factor is calculated based on the annual average of the benchmark passive interest rate and the number of months elapsed between the acquisition date and the transfer date, divided by twelve.

Real estate developers and construction companies are allowed to include, within the acquisition value, the costs and expenses incurred in the construction subject to transfer, provided that they may be considered deductible expenses for income tax purposes.

4. Extraordinary Gain, Tax Base, and 75% Rate

The extraordinary gain, on which a 75% tax is paid once it exceeds 24 unified basic salaries, corresponds to the difference between the transfer value of the property — the value stated in the deed — and the adjusted acquisition value.

The adjusted acquisition value results from the sum of the acquisition value plus the ordinary gain.

The tax return and payment must be made before the execution of the deed, for the benefit of the municipalities, which are considered the active subjects of the tax.

If the municipalities have not exercised their assessment authority, the Internal Revenue Service — SRI — shall exercise it subsidiarily.

5. Loss of Value

Municipalities are required to recognize up to 50% of the value of the impact caused to a property by a public works project, through credit notes.

In the case of public works carried out by the Central Government, there is also an obligation to recognize the impact.

However, there is no clear mechanism to pay the affected party.

The loss of value caused by declarations of cultural and historical heritage is not mentioned.

6. Cadastral Update

Municipalities are required to update appraisals to between 70% and 100% of the commercial appraisal value when requested by a financial institution for a loan or for a sale with a mortgage.

The greatest responsibility, not only administrative but also civil, falls on the competent municipal authorities for the amounts not collected as property tax due to the failure to update cadastral appraisals, or for any other damage caused to citizens by such omission.

The modernization of cadasters becomes grounds for removal from office.