Dealings in Properties

Chapter 12
 Definition
Dealings in properties involve the sale,
exchanges & other disposition of properties
such as ordinary assets or capital assets
 Taxability
• Dealings in ordinary assets are subject to
regular income tax
• Dealings in capital assets other than domestic
stocks & real properties are also subject to
regular income tax
 Determination of Gains Or Losses in
Dealings in Properties
Selling price ₱-
Less: Tax basis/adjusted basis -
Gain or loss ₱-
 Selling Price
• The sum of money received
• Fair value of non-cash properties received
 Tax basis
• Cost, carrying amount or depreciated cost of
an asset
 Tax treatment of ordinary gains &
losses
• Ordinary gains – separate items of gross
income subject to regular income tax in full
• Ordinary losses – deductible from gross
income in full
Tax treatment of capital gains & losses
• Capital losses are deductible only to the
extent of capital gains from dealings in capital
assets other than domestic stocks & real
properties, thus
• Net capital gain is an item of gross income
• Net capital loss is not an item of deduction
from gross income
Determination of net capital gain or
net capital loss
 Individual taxpayers
• Holding period rule:
1) Capital assets held ≤ 1 year – 100% capital
gain or loss is recognized
2) Capital assets held > 1 year – 50% of the
capital gain or loss is recognized
 Corporate taxpayers
• 100% of capital gain or loss is recognized
regardless of holding period
 Illustration
Mr. Tayabas , a self-employed resident citizen, reported P800,000 gross
receipts & P300,000 cost of services & P240,000 business expenses. He
also had the following dealings in properties during year:
Dealings in properties Holding period Gain(loss)
Ordinary assets
Equipment 8 months P20,000
Old machines 18 months ( 25,000)
Capital assets
Foreign bonds 4 months P100,000
Domestic bonds 15 months ( 150,000)
Domestic stocks 8 months 80,000
Foreign stocks 18 months 40,000

How much is net capital gain subject to regular income tax?

Assuming this is a corporation, how much is net capital gain/(loss) for
regular income tax purposes?
 Solution 1
Gain on foreign bonds (P100,000 x 100%) P100,000
Loss on domestic bonds (150,000 x 50% ) ( 75,000)
Gain on foreign stocks (P40,000 x 50%) 20,000
Net capital gain P 45,000
=======

Solution 2
Gain on foreign bonds (P100,000 x 100%) P100,000
Loss on domestic bonds (150,000 x 100%) ( 150,000)
Gain on foreign stocks (P40,000 x 100%) 40,000
Net capital loss (P 10,000)
=======
 Rationale for the holding period
• Legislative compromise to individual taxpayers
because tax due will be subject to higher tax
brackets upon realization of capital gains
• Doesn’t apply to corporations because of the
fixed rate of 25% regardless of when sold
 Effects of Situs on Dealings in
Properties
• Resident citizens & domestic corporations –
taxable on dealings in properties regardless of
location
• All other taxpayers – taxable on dealings in
properties in the Philippines only
 Net Capital Loss Carry Over (NCLCO)
• Individual taxpayers (corporations not allowed)
are allowed to carry-over net capital loss as a
deduction against net capital gain of the
following year (1 year only) subject to these
limits:
1) Limit 1 –the amount of net income in the year
the net capital loss was sustained
2) Limit 2 –The available net capital gain in the
following year
• In short, NCLCO is the lowest of actual net
capital loss, limit 1 and limit 2
 Illustration
Mr. Quintey reported the following in 2020 & 2021:
2020 2021
Net income before dealings in properties P70,000 P300,000
Dealings in ordinary assets: ====== =======
Ordinary gains P 40,000 P 30,000
Ordinary losses ( 80,000) ( 50,000)
Dealings in capital assets:
Capital gains P20,000 P 80,000
Capital losses ( 60,000) ( 30,000)
Net capital gains (loss) (P40,000) P 50,000
======= ========

How much is deductible NCLCO & net capital gain in 2021?

 Solution
2020 2021
Net income before dealings in properties P70,000 P300,000
Ordinary gains 40,000 30,000
Ordinary losses ( 80,000) ( 50,000)
Net income before dealings in capital assets P30,000 P280,000
====== ========
2020 2021
Net capital gain (loss) ( P40,000) P 50,000
NCLCO: (lowest of 30k, 40k, & P50k) 30,000 ( 30,000)
Net capital gain -2021 P 20,000
========
 Rationale for Limit 1
• Tax benefit rule – taxpayer is benefitted only
to the extent of the net income that will be
wiped out if the law allowed deductibility of
capital loss
 Rationale for Limit 2
• 1 year rule for NCLCO could be breached
because another net capital loss will be
created
Special Rules in Determination of Tax Basis
 Assets acquired by purchase
1) Acquisition cost for:
a. Capital assets
b. Non-depreciable ordinary assets (e.g., land)
c. Any asset purchased for inadequate
consideration
2) Depreciated cost for depreciable ordinary
assets
 Assets received by exchange
• Tax basis shall be the fair value of asset
received
 Assets received by gratuitous title
• Donation
Whichever is lower of:
a) The tax basis on the hand of the donor or the last
preceding owner by whom it was not acquired by
donation
b) Fair market value at the date of gift
• Inheritance – fair value at death of decedent
 Shares received by way of tax-free
exchanges
a) For pure share-for-share swap, tax basis of
shares exchanged or given is the tax basis of
shares received
b) For share-swap with non-cash consideration,
tax basis shall be the substituted basis
 Substituted basis
• Transferor
Tax basis of shares exchanged ₱-
Add: Gain recognized -
Amount treated as dividends of shareholder -
Less: Cash & fair value of other properties received -
Tax basis of new shares received by transferor ₱ -
===
• Transferee
Original basis in the hands of the transferor ₱ -
Add: Gain recognized to the transferor -
Tax basis of the shares received by transferee ₱ -
==
 Tax Free Exchanges
1) Corporate reorganization
2) Initial acquisition of control

Same concepts as introduced in Chapter 6,

except that this is applicable to foreign stocks or
bonds
 Illustration
Pursuant to a plan of merger, ABC Company exchanges a vast track of land
with a fair value of P12,000,000 & tax basis of P10,000,000 for the stocks of
DEF Company with fair value of P12,500,000 & par value of P11,000,000.
For ABC Company: Fair value of DEF shares received P12,500,000
Tax basis of land exchanged 10,000,000
Indicated gain (not to be recognized) P 2,500,000
DEF shares shall carry tax basis of P10M.

For DEF Company: Fair value of land received P12,000,000

Tax basis of stocks exchanged (par) 11,000,000
Share premium (not taxable) P 1,000,000
 Initial Acquisition of Control
No gain or loss shall also be recognized if
property is transferred to a corporation by a
person in exchange for the stocks or units of
participation in such a corporation of which as a
result of such exchange, said person, alone or
together with others not exceeding 4, gains
control of said corporation
 Illustration
Mr. Ali exchanged his land & building with tax
basis of P18M for the stocks of ABC Company
w/total par value of P15M. Consequently, Mr. Ali
obtained 51% ownership in ABC Company.

No gain or loss shall be recognized as it resulted

in corporate control.
 Taxable Exchanges
• Share-for-share swap/property-for-share swap
NOT pursuant to a plan of M&C
• Transfer of properties to a corporation alone
or w/4 others that did NOT result in
acquisition of corporate control
• Transfer of properties to a controlled
corporation AFTER initial acquisition of control
 Exchanges not plainly for stocks
• The tax exemption rule proceeds from the
theory that there is no realization of income
because the shareholder/security holder is
still part of the same corporate entity
• If transferor received considerations other
than stocks in the exchange, gains but not
losses shall be recognized to the extent of
cash/properties received
 Illustration
Ms. Denver is a holder of Aurum Company
shares costing P100,000. Aurum Company is
being consolidated with King Corporation. She
received P105,000 worth of King shares &
P15,000 cash in exchange for Aurum Company
shares.

How much gain should be subject to tax?

 Solution
King shares received P105,000
Cash received 15,000
Total consideration P120,000
Less: Tax basis of stocks exchanged 100,000
Indicated gain P 20,000
=======
Realized gains to be reported is to the extent of cash
received of P15,000
 Applicable tax on the realized gain
If Ms. Denver is a:
Aurum Corp is a: Dealer in stocks Non-dealer in stocks
Domestic corporation Ordinary gains subject to Capital gain subject to 15%
regular income tax CGT
Foreign corporation Ordinary gains subject to Capital gain subject to
regular income tax holding period rule under
regular income tax
Tax basis of King shares to Ms. Denver
Tax basis of shares exchanged P100,000
Add: Gain recognized 15,000
Amount treated as dividends -
Less: Cash & fair value of items received 15,000
Tax basis of new shares received P100,000
=======
 Tax basis of Aurum shares to King
Original basis to Ms. Denver P100,000
Add: Gain recognized by Ms. Denver 15,000
Tax basis of Aurum shares acquired P115,000
========
Effect of split & stock dividends on tax basis of stocks
• Tax basis of stocks previously held should be spread over
the total shares held following a share split or stock
dividend declaration

Example: A holds 1,000 shares of B Corporation at a cost of

P100,000. B Corporation declared 25% stock dividends.
Subsequently, A sold 500 shares for P150/share.
New total shares held by A after stock dividend = 1,000 x
125% = 1,250
New unit cost = P100,000/1,250 =P80

Sales proceeds (500 x P150) P75,000

Less: Cost (500 shares x P80) 40,000
Gain P35,000
======
Gain on sale of indebtedness with maturity of more than 5
years

• Exempt from income tax

 Properties sold for less than adequate
consideration

• Excess of Fair Market Value over Selling Price

is subject to transfer tax
• Difference between Selling Price & tax basis is
accounted for as gain or loss
 Capital gains & losses of GPP
• Rules on dealings on capital assets by
corporations apply to partnership including
GPP
 Sale of Properties w/excess mortgage
assumed by buyer
• Excess of mortgage assumed over tax basis of
property is reportable as gain
Bohol Corporation sold its old office w/ tax basis of P2M which
was encumbered by P2,500,000 mortgage. The buyer assumed
the mortgage & paid Bohol P200,000. Ordinary gain shall be:
Cash received P200,000
Excess mortgage over cost (2.5M-2M) 500,000
Ordinary gain P700,000
 Wash Sales
• Same principles as discussed in chapter 6,
except that this is for regular income taxation
on sale by non-dealers of:
a) Foreign shares
b) Debt securities, foreign or domestic
 Wash Sales Rule
• Wash sale of securities is deemed to occur when within 30
days before and 30 days after the sale (61-day period), the
taxpayer acquired or entered into a contract or option to
acquire substantially identical securities
• Gains are taxable, losses are not deductible
• Securities for purposes of the 61-day rule include stocks and
bonds
 Illustration
A taxpayer had the following transactions in the shares of Nitros
Company, a foreign corporation, on the following dates:
Date Transactions Quantity Price Amount Gain (Loss)
2020
Jan 4 Purchase 10,000 P20 P200,000
Jan 26 Sale 10,000 24 240,000 P40,000
May 17 Purchase 12,000 17 204,000
June 18 Purchase 3,000 17 51,000
July 15 Sale 5,000 15 75,000 (10,000)
2021
Oct 1 Sale 10,000 22 220,000 50,000
Case 1 – Individual not dealer in stocks
• Both wash sale rule & holding period shall apply
Loss in the July 15, 2020 sale P10,000
Deferred loss (3,000/5,000) x P10,000 6,000
Realized Loss P 4,000
=======
Gain in the October 1, 2021 sale P50,000
Less: Increase in basis of shares sold 6,000
Gain to be recognized in October 1, 2021 P44,000
=======
Summary of gains/losses for 2020 and 2021:
2020 2021
Capital gain P40,000 P44,000
Less: Capital loss 4,000 -
Net capital gain P36,000 P44,000
Holding period percentage 100% 50%
Net capital gain P36,000 P22,000
======= =======
Case 2 – Individual, dealer in stocks
Wash sales rule and holding period don’t apply

2020 2021
Ordinary gain P40,000 P50,000
Ordinary loss (10,000) -
 Case 3 – Corporation, not dealer in
stocks
Wash sales rule applies but holding period doesn’t
2020 2021
Capital gain P40,000 P44,000
Less: Capital loss 4,000 -
Net capital gain P36,000 P44,000
Holding period percentage 100% 100%
Net capital gain P36,000 P44,000
======= =======
Case 4 – Corporation, dealer in stocks
Wash sales rule and holding period don’t apply

2020 2021
Ordinary gain P40,000 P50,000
Ordinary loss (10,000) -
 Note
If taxpayer is taxable only for income in the
Philippines, none of the gains or losses shall be
recognized for Philippine income tax as the
situs on gain on sale of foreign stocks is abroad
 Summary of Rules
Applicability of:
Taxpayer type Wash sale rules Holding Period
Individual: Non dealer √ √
Individual: Dealer x x
Corporate: Non dealer √ x
Corporate: Dealer x x
 Transactions considered exchanges
• Retirement of bonds, debentures, notes or certificates & other
evidence of indebtedness (The amount received by the holder upon
retirement of the indebtedness is deemed received in exchange thereof)
• Short sale of properties (sale by speculator of borrowed securities in
anticipation of decline in value)
• Failure to exercise a privilege or option to buy or sell property that is
capital asset (capital loss deductible from capital gain but ordinary
gain/loss to dealers)
• Security becoming worthless (capital loss as a rule but ordinary loss to
dealers)
• Receipt of liquidating dividends (gains or losses are governed by rules
on regular income taxation not to 15% CGT)
• Amount received in liquidation of a partnership is deemed in exchange
of the partner’s interest in the partnership (business partnership –
subject to CGT; GPP – subject to regular income tax)
• Redemption of shares for cancellation or retirement (subject to regular
income taxation rules whether shares are domestic or foreign)
• Voluntary buy-back of shares (domestic shares - subject to CGT rules;
foreign stocks – subject to regular income taxation rules)