May 2020 GAIN OR LOSS FROM SALE OR EXCHANGE OF PROPERTY Atty. C. Llamado Sale or exchange of properties are classified into: a) On the sale of domestic shares. | 1. Sales resulting to Capital Gains (subject to “CGT”) b) On the sale of real property classified as capital assets. 2. Tax-Free Exchanges - where No Gain nor Loss is Recognized i 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 3. Sales or Exchanges Where 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 persons under Section 36(B) of the Tax Code. ©) Mlegal transactions. d) Wash sale losses of securities 4, (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 is subject to CGT) = If the transaction is a sale, the gain or loss to be recognized is computed as follows: | Sale XK | Less: Basis (xxx) Gain (Loss) xxxx - 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. The gain or loss i is computed as follows: FMV of the property received 20x Less: Basis of property given (xxx) Gain (Loss) 000%May 2020 BASIS a) Ifproperty was acquired by purchase, the basis of the property is the cost to the buyer- b) If property was acquired by inheritance, the basis of the property is the FMV of the Property at the time of death of the decedent (step-up in basis). c) If the property was acquited by gift, the basis of the property is the basis in the hands of the donor. Except that if such basis is greater than the FMV of the property at the time of the gift, then the basis shall be such FMV for the purpose of determining the loss. 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 4 ~ Afiera 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 xx Plus: Improvements 300K Less: Accumulated Depreciation Gom) Adjusted Basis xxxx 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 an individual taxpayer of real property to government in the exercise of the latter’s power of eminent domain; and ) Gain or loss in the sale of real property classified as capital asset of an RFC or NRFC.May 2020 CLASSIFICATION OF PROPERTIES FOR TAX PURPOSES Cc Assets a) Stock included in inventory; ) Property primarily held for sale; ©) Property used in business which is capitalized; 4) Real property used in the trade, business, or profession of the taxpayer ‘Asset which is not an ordinary asset, such as: (1) personal or non-business property or (2) asset held merely for investment, or (3) property not used in business How taxed? Gain is 100% included in the ITR. Loss is 100% deducted in the ITR if taxpayer itemizes deductions. How Taxed? Sale oF(@) domestic | Sale of capital assets other than shares held as capital | domestic shares held as capital assets, assets; (b) zeal properties | or RPCAs. in the Philippines classified as capital assets (RPCA) Sabject to FTs: Gain/Loss (“G/L”) is recognized, but only Net Capital Gain is 1) Capital gains taxon | included in the ITR: sale of domestic shares; 1) If taxpayer is an individual: 2) Capital gains tax on sale of real property ST! G/L = 100% recognized located in the LT? G/L= 50% recognized Philippines classified as capital assets. 2) If taxpayer is a corporation: 100% recognized whether ST or LT 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 year asa 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. ee * Long-term — ~ holding period of taxpayer is not more than | 0 pear, holding period of taxpayer is more than | year,May 2020 Other Transactions Resulting in Capital Gains or Losses Where There is NO SALE 1) 2) 3» 4) 3) 6) 2 When stocks or bonds held as capital assets become worthless, capital loss is recognized. When bonds (held as capital assets) 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 loss to the shareholder 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 partnership Less: His share in the undistributed partnership 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. 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 Notes: 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 deductible 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 for Non-Deductible Loss: ‘ormutla for Tax No. of Shares Acquired Within 6] day period x Loss = Non-deductible Loss No. of Shares Sold is of Re-Acquired Shares: Cost of Acquisition XXX + Wash Sale Loss 20x New Tax Basis/Cost BAXKMay 2020 ‘TAX-FREE EXCHANGES OF PROPERTIES PURSUANT TO A MERGER OR CONSOLIDATION (CORPORATE REORGANIZATION)? (1) IF in pursuance of a plan of merger or consolidatio (2) 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 a 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, Tax Consequences: (1) The Transferor shall NOT recognize gain o loss (i.e., no CGT, 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 P5 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 However, this gain will not he recognized and therefore is not taxable. 2 Sec. 40(C)(2), NIRC. , ‘ Whether voting or non-voting, * Whether voting or non-voting, Whether voting or non-voting. 7 Voting. * The 4 other persons must also be transferors of property, * However, if the Properties transferred by the transferor are used in business or held for sale or for lease, the transfer shall be subject to VAT (equivalent to 12% of the FMV of the property transferred) 2May 2020 (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 = Pl/share x 500 shares = P500. (©) 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) (500) Gain Pr 19,500, Since the Y shares are not traded in the stock exchange and are capital assets, the 19,500 gain shall be subject to the 15% 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 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 P xxx Less: (a) Money received Po xxx (b) FMV of property received xXx _(xxx) Balance P xxx Add: (a) Gain recognized on the exchange P 200K (b) Amount treated as dividend XXX Ox Basis (Cost) of the stock received P xxxx Example: In the previous example, pursuant to a merger Marian exchanged her 100 X shares for 500 Y shares (FMV = P7 per share) plus land (FMV = P5,000) plus P2,000. (a) How much gain shall Marian recognize? 7,000| May 2020 I | Fair market value of Y shares received (P7 x 500 shares) P 3,500) Plus: Boot: Land 5,000 Cash = 2,000 7,000 10,500 Less: Basis in X shares transferred (P5 x 100 shares) (500) Gain P __10,000 But, Gain to be recognized shall not exceed the boot received in the amount of P7,000. (b) What will the basis of the Y shares of Marian? P500 Cost (basis) of the X shares transferred Pr 500 Less: (a) Money received P 2,000 (b) FMV of land received 5,000 —_(7,000) Balance P (6,500) Add: Gain recognized on the exchange 7,000 Basis (Cost) of the Y shares received Pr 500 (c) What is the basis of the land received in the hands of Marian? 5,000