October 2016 GAIN OR LOSS FROM SALE OR EXCHANGE OF PROPERTY Atty. C. Llamado Sale or exchange of properties may give tise to: . Capital Gains (subject to “CGT") a) On the sale of domestic shares, 6) On the sale of real property classified as capital assets. . Tax-Free Exchanges - No Gain or Loss is Recognized a) Tax-free exchanges pursuant to a corporate reorganization under Section 40(C)(2) of the Tax Code (merger or consolidation) b) Like-Kind Exchanges . Sales or Exchanges - Gain, but Not Loss is Recognized a) Exchanges not solely in kind pursuant to a corporate reorganization where boot is received. b) Transactions between related persoas under Section 36(B). ©) Mlegal transactions. . (a) Sale or Exchange of Ordinary Assets and (b) Sale or Exchange of Other Capital Assets (i.e. capital assets other than those whose sale shall be subject to CGTs) ~ Ifthe transaction is a sale, the gain or loss to be recognized is computed as follows: Sale 20x Less: Basis. (xxx) Gain (Loss) >000 If the transaction is an exchange, the property received must be essentially different from the property disposed of, otherwise no gain or loss is recognized (like-kind exchange), The gain or loss is computed as follows: FMV of the property received 2K Less: Basis of property given (xx) Gain (Loss) OKOctober 2016 BASIS a) If property was acquired by purchase, the basis of the property is the cost to the buyer. ) If property was acquired hy inheritance, the basis of the property is the FMV of the property at the time of death of the decedent (step-up in basis). ©) If the property was acquired by gift, the basis of the property is the basis in the hands of the donor. 4) If property was acquired for less than an adequate consideration, the basis of the property is the amount paid, ©) If property was acquired in a previous tax-free exchange where gain or loss is not recognized under Section 40(C)(2), the basis is the substituted basis. Adjusted Basis ~ After a property is acquired, its basis can be increased by improvements that materially add to its value or life, and is decreased by accumulated depreciation. Formula: Basis of property rox Plus: Improvements OK Less: Accumulated Depreciation, (ox) : Adjusted Basis ERX Use of Basis Basis is used to determine: a) Gain or loss in transactions involving ordinary assets. b) Gain or loss involving capital assets which are not subject to the CGT. ©) Gain or loss in the sale of domestic shares not traded in the stock exchange, 4) Gain or loss in forced sale of real property to government in the exercise of the latter’s power of eminent domain,October 2016 CLASSIFICATION OF PROPERTIES FOR TAX PURPOSES Capital Assets inventory; ') Property primarily held for sale; ©) Property used in business which is ‘Asset which is not an ordinary asset: (2) parsonal or non-business property or @) asset held merely for investment, or capitalized; (3) property not used in business 4) Real property used in the trade, usiness, or profession of the texpayer How taxed? How Taxed? Subject to FIs: Gain/Loss (“G/L”) is recognized and Gain is 100% taxable Loss is 100% taxable Both are included in the IER. ineluded in the ITR: 1) Capital gains tax on , sale of domestic 1) If TP is an individual: shares; 2) Stock transaction tax on | ST G/L = 100% recognized sale of shares thru [PO | LT G/L= 50% recognized (See. 127(8)) 3) Capital gains taxon | 2) If TP is a corporation: sale of real property classified as capital 100% recognized whether ST or LT assets ‘Other Rules: 3) Capital losses are allowed only against capital gains 4) Any net capital loss (net capital loss carry-over) of an individual taxpayer can be carried over to the next succeeding vearas « ST NCL, but not to exceed the net income for the year in which the capital loss was incurred. Corporations are not allowed any net capital loss carry-over.October 2016 Other Transactions Resulting in Capital Gains or Losses Where There is NO SALE ) 2) 3) 4 5) 8 ‘When stocks or bonds held as capital assets become worthless, capital loss is recognized. When bonds are retired. Gains or losses from failure to exercise options (option gains or losses). When the assets of a corporation are distributed in complete liquidation thereof (liquidating dividend), Capital gain or ioss to,the sharcholder is recognized. Redemption of preferred shares. Liquidation of partnership. Capital gain or loss is recognized to the partner. Formula: Amount received for his partnership interest Less: His investment in the parmership Less: His share net income Gain or Loss to Partner (subject to holding period qualification) Gains or losses from short sales. “Short selling” is selling something one does not own in the future at a particular price in the hope that the property goes down in value. For tax purposes, a short sale is deemed consummated upon delivery of the property to cover the short sale.October 2016 WASH SALE LOSS Requisites: 1) Sale of securities at a loss; and 2) Identical securities were purchased within a 61-day period, beginning 30 days before the sale, and ending 30 days after the sale. 3) The taxpayer is either (a) not a dealer in securities, or (b) if a dealer, the sale was not made in the ordinary course of business. a) “Purchase” includes entering into a contract or option to acquire identical securities. b) IF taxpayer is a dealer in securities and the sale was made in the ordinary course of \. business, the loss on the sale is dedustible in the ITR. IF taxpayer is not a dealer in securities or is a dealer but the sale was not made in the ordinary course of business, the Joss on the wash sale is a capital loss, but is not deductible against capital gains. Formula {Sk Non-Deduetible Loss: \ ‘No. of Shares Acquired Within 61 day period x Loss = Non-deductible Loss \\ No. of Shares Sold Cost of Acquisition 20% + Wash Sale Loss XXX New Tax Basis/Cost 3XXXOctober 2016 ‘TAX-FREE EXCHANGES OF PROPERTIES PURSUANT TO A MERGER OR CONSOLIDATION (CORPORATE REORGANIZATION) (2) IF in pursuance of a plan of merger or consolidation: (@ A corporation (transferor), which is a party to a merger or consolidation, exchanges property solely for stock in a corporation, which is a party to the merger or consolidation; or (b) A shareholder (transferor), _exchanges stock in a corporation, which is a party to the merger or consolidation, solely for the stock of another corporation also a party to the merger or consolidation; or (© A security holder (transferor), of 2 corporation, which is a party to the merger or consolidation, exchanges his securities in such corporation, solely for stock or securities in another corporation, a party to the merger or consolidation; or OR (2) A person (transferor), transfers his property to a corporation in exchange for stock or unit of participation in such a corporation of which, as a result of such exchange said person, alone, or together with others, not exceeding four (4) persons, gains control of said corporation (See. 40 (C) 2), NIRC). Tax Consequences: (1) The transferor shall NOT recognize gain or loss (i.e., 10 COT, no income tax, no CWT, no donor’s tax, no VAT); and (2) The basis (cost) of the stock or securities received by the transferor shall be the same as the basis of the stock, property, or securities transferred (substituted basis). Example: Marian bought 100 shares of X Corporation at PS per share. Later X Corporation decided to merge with Y Corporation, Pursuant to which Marian exchanged her 100 shares of X Corporation for 500 shares of Y Corporation which had a FMV at that time of P7 per share. (a) What is the gain of Marian? Fair market value of Y shares received (P7 x 500 shares) P 3,500 Less: Basis in X shares transferred (P5 x 100 shares) (500) Gain P 3,000 ‘This gain will not be recognized and therefore not taxable. (b) What will the basis of the Y shares of Marian? ‘The basis of the Y shares will be the same basis in her X shares = P1/share x 500 shares = 500.October 2016 (c) If Marian sells all the 500 Y shares to Ivy for 20,000, what will be the tax consequence to Marian? Selling price of Y shares P 20,000 Less: Basis (P1 x Y 500 shares) (600) Gain P 19,500 Since the ¥ shares are not traded in the stock exchange and are capital assets, the P19,500 gain shall be subject to the 5% , 10% CGT. HOWEVER, if the “Transferor” receives not only stock or securities, but also money or property, GAIN but NOT LOSS shall be recognized. ‘Note: The money and/or property received is called “boot.” Tax Consequences: (1) Gain shall be recognized < Money + FMV of Property Received EXC: No gain is recognized if the transferor is a corporation and the boot is distributed in accordance with the plan of merger or consolidation, (2) Basis of the shares received by the transferor shall be computed as follows: Formula — Cost (basis) of the stock or property transferred Poxxxx Less: (a) Money received Pox (b) FMV of property received 2000 (xxx) Balance P xox Add: (a) Gain recognized on the exchange Po xxxx (b) Amount treated as dividend XXXK XXX Basis (Cost) of the stock received Poo‘CPA REVIEW SCHOOL OF THE PHILIPPINES Manila INSTALLMENT / DEFERRED PAYMENT METHOD OF REPORTING INCOME Dela Cruz / De Vera / Lopez / Llamado 1, Which of the following statements is not correct? Those who make a casual sale or disposition of personal property on the instaliment plan may elect the instalment basis of reporting income if a. The personal property sold is of a kind which would be included in the inventory, b. The selling price exceeds P1,000 ¢. The sale is in instalment 4. The initial payments do not exceed 25% of the selling price. 2. Income from a deferred sale of the property may be reported using The instalment method only Deferred payment method only Either the instalment or deferred payment method | Neither the instalment nor deferred payment method pegs 3. In 2014, A sold a piece of land which hand a cost of P1,000,000 for a selling price of P4,000,00. The sale called for an assumption by the buyer of a mortgage on the land of P1,500,000, cash of P500,000 on the date of sale and installment payments of P500,000 every year thereafter. The land is an ordinary asset. The income to be reported in 2014 under the installment method of operating income is a. P500,000 . P750,000 ¢. P375,000 a P1,000,000 4. A:sold his ring, a capital asset, on February 14, 2014. The ring was acquired on January 14, 1980 at a cost of P60,000. The terms of payment are as follows: Down payment, February 14, 2014 25,000 Installment payment, February 14, 2015 23,000 Installment payment, February 14, 2016 [5.00 Mortgage assumed by the buyer 20,000 Total }20,000 The taxable gain to be reported by A in 2014 is 8, P6000 bajrers gain b- P30,000 farvatie 0. PIS,000 9 P7,500 acedg dain f 5. F, sold the following capital assets | Land} Land 2 Land 3 Land 4 Selling Price 400,000 600,000 800,000 P1,200,000 Cost 200,000 250,000 400,000 "400,000 Commission paid 30,000 70,000 - : Selling expenses incurred 20,000 30,000 40,000 50,000 Terms of sale: Down payment, Feb. 14, 2013 50,000 70,000 50,000 150,000 Installment payments: July 14, 2013 50,000 70,000 50,000 150,000 July 14, 2014 150,000 100,000 200,000 200,000 July 14, 2015 150,000 260,000 - 200,000 Mortgage assumed by the buyer : 100,000 500,000 500,000 ‘The final tax for 2013 is a. P180,000 b. PL12,080 c. P85,080 4. P82,080 Tax 80-106. A sold a delivery truck in instalment on February 14, 2013, as follows: Down payment, February 14, 2013 40,000 Installment payment, February 14, 2014 80,000 Installment payment, February 14, 2015 80,000 Acquisition cost of delivery truck 300,000 Accumulated depreciation up to February 14, 2013, 200,000 The income to be reported in 2013, is a, P100,000 b. 40,000 ©. P20,000 d. P10,000 7, B sold the following capital assets. Land. Land 2 Land 3 Selling Price 150,000 500,000 800,000, Cost 100,000 550,000 300,000 Gain (loss) P.50,000 P.30,000) 2500,000 Down payment, Feb. 14, 2014 P 15,000 P 50,000 20,000 Installment payments: July 14, 2014 7,500 25,000 75,000 Dee, 14, 2015 7,500 25,000 75,000 Dec. 14, 2016 120,000 400,000 630,000 ‘The final taxes due in 2014 are a, P87,000 b, P1,550 ©. P18,000 4, -P9,000 8. The following refer to the transactions of D regarding the sale of her necklace, a capital asset: Down payment, February 14, 2013 90,000 Installment payment, February 14, 2014 90,000 Installment payment, February 14, 2015 60,000 Mortgage assumed by the buyer 360,000 Cost when acquired on March 14, 2003 300,000 ‘The taxable gain for 2013 is a. P300,000 . P150,000 ¢, P75,000 4. P45,000 9. A, a teal estate dealer sold a house and lot for P600,000 on November 20, 2011. The cost of the property is P375,000. Terms are: a) Down payment of P100,000 and b) Balance payable in monthly instalments of P25,000 beginning December 20, 2011. The income to be reported in 2011 is, a, P225,000 , P125,000 c. P46,875 4. P37,500 10. Using the preceding number, except that the asset above is « capital asset, the capital, gains tax payable in 2011 is a, 36,000 b. P7,500 ©. P6,000 4d. P3,750 11. On December 1, 2011, a real estate dealer sold a residential land for P6M (cost is P3.6M) receiving P2M as down payment and a promissory note for the P4M balance payable at P400,000 a month beginning January 1, 2012, The promissory note has fair market value equal to 75% of its face value. If the income is to be reported under the deferred payment method, the income in 2011 is a, P2,400,000 ». P1,400,000 . P800,000, 4. P1,200,000 12, On June 1, 2013, A sold shares of stocks of a resident foreign corporation held as capital assets for 24 months for P500,000 (cost of P300,000), payable as follows: P200,000 on the date of sale and the balance is secured by a promissory note where fair market value is 85% of its face value, Payments on the note were as follows: January 1, 2014 100,000 Tune 1, 2014 100,000 December 1, 2014 100,000 The capital gain in 2013 is a. P200,000 b. P85,000 e. P77,500 d. P100,000 ‘The End!!! Tax 80-10October 2016 INSTALLMENT METHO! Atty. C, Llamado Installment Method Defined The installment method is a special method of accounting whereby income ox installment sales of property during the year is allowed to be reported in installments in proportion to the installment payments actually received which the gross profit bears to the total contract price (See, 49 (A), NIRC). The 3 Cases Where Income May be Reported in Installments: () Sale of personal property by a dealer — Dealers in personal property who regularly’sell or otherwise dispose of personal property on the installment plan (Sec. 49 (A), NIRC). (b) Casual sale of personal property ~ Persons who make a casual sale or casual disposition of personal property subject to the following conditions: (1) The selling price exceeds P1,000; Q) The initial payment must not exceed 25% of the selling price; and (3) The property sold is not a kind which would be includible in the inventory if on hand at the close of the taxable year (Sec. 49 (B), NIRC). (c) Sale of real property — Persons who sell or otherwise dispose of real property on installment plan are also allowed to use the installment method to report the gain on the sale subject to one condition: That the initial payment must not excegd 25% of the selling price (Sec. 49 (B) and (C), NIRC). Important Installment Method Terms (@) SELLING PRICE ~ The amount realized on the sale Cash received Po ox FMV of the property received 2X Installment obligations of the buyer (evidence of indebtedness) XXX Mortgage assumed by the buyer XXX Selling price PoxOctober 2016 (b) pet PRICE ~ The amount which the purchaser contracts to pay the seller. It incluc Selling price Px0x Less: Mortgage assumed by the buyer XXX Balance Pox ‘Add: Excess of mortgage over cost OK Contract price P xxx ‘Note: Mortgage assumed by the buyer, if any, is part of the selling price, but is not part of the contract price, (© INITIAL PAYMENTS ~ Payments received in cash or property (other than evidence of: indebtedness of the purchaser) during the taxable year in which the sale is made. Downpayment Price Installments received in year of sale 20004 Total 2 racroo ‘Add: Excess of mortgage over cost XXX Initial payments P xox ‘Notes: 1) “Initial payments” means at least one (1) other payment in addition to the initial payment, If there is no payment during the first year, the income may not be returned on the installment basis; 2) Commissions and other selling expenses paid or incurred by the vendor are not to be deducted or taken into account in determining the amount of the “initial payments”, the “total contract price,” or the “selling price” (Sec. 175, Rev. Reg. No. 2-1940). Formula to Report Income under the Installment Method Gross Pro! Installment payments ___Income to be reported Contract Price © ™ actually received for the year or Installment payment received Gross Profit _ _ Income to be reported Contract Price ia for the year Note: The installment method does not apply to deductions. Deductible items shall be deducted for the taxable year in which the items are “paid or incurred” or “paid or accrued.”October 2016 Sale of Real Property (Capital Asset) The sale of real property which is a capital asset is subject to final capital gains tax, whether the seller is an individual, estate or trust, or a corporation. Can the final tax be paid in installments? Yes, the final tax can be paid in installments if the initial payments do not exceed 25% of the selling price, Formula to compute the final tax in insta:Iments Initial Payment In year of sale: Conran Price x Final Tax ; . _ Installments Received : Tatbsequent years: Contract Price “Final Tax Sale of Shares of Stock of a Domestic Company (Capital Asset) When the shares are not traded through the stock exchange — the tax is based on the net capital gein realized: Not over 100,000 % On any amount in excess of 100,000 10% (@) If sold by an individual - Subject to final tax. i (b) If sold by a corporation — Subject to final tax. | (©) If the shares are not traded through the stock exchange and are sold in installments, |can the final tax be paid in installments? : | Yes, if the initial payment is not more than 25% of the selling price.