Module 5 – Part 3

Dealings in Properties
Prepared by: Nelia I. Tomas, CPA, LPT
ALLPPT.com _ Free PowerPoint Templates, Diagrams and Charts
Learning Objectives
After completing the lesson, the students will be able to
1. Distinguish capital gains subject to regular tax from those subject to capital gains tax
2. Understand what constitutes selling price and the rules on tax basis
3. Understand the tax treatment of gain or loss on ordinary assets and other capital assets
4. Master the rules on the measurement of the net capital gain or loss and the rules on net
capital loss carry over
DEALINGS IN PROPERTIES
 Dealings in properties involve the sale, exchanges, and other disposition of
properties such as ordinary assets or capital assets.
 Ordinary assets are assets used in the business of the taxpayer such as
inventories, supplies and property, plant and equipment.
 Capital assets are assets other than ordinary assets.
 Dealings in ordinary assets are subject to regular income tax. Dealings in
capital assets, other than domestic stocks and real properties, are also
subject to regular income tax.
 Dealings in ordinary assets may result in an ordinary gain or an ordinary
loss. Dealings in capital assets may likewise result in a capital gain or a
capital loss.

Determination of Gains or Losses in Dealings in Properties

Selling price P xxx
Less: Tax basis or adjusted basis of the asset disposed xxx
Gain or loss P xxx
DEALINGS IN PROPERTIES
What is selling price?
Selling price includes the amount realized from the sale and other disposition
of property which shall include:
1. The sum of money received and
2. Fair value of non-cash properties received

What is tax basis?

Tax basis refers to the cost, carrying amount, or depreciated cost of an asset.
The cost of an asset is the value forgone to acquire it. Generally, it is the
purchase price or the fair value of consideration paid in acquiring the property
disposed of.
DEALINGS IN PROPERTIES
Tax Treatment of Ordinary Gains and Losses
 Ordinary gains are separate items of gross income subject to regular income tax.
 Ordinary losses are items of deductions from gross income in the determination of net
income from business or profession.
 Ordinary gain is taxable in full while ordinary loss is deductible in full.
 The gain or loss on sale by dealers of properties is an ordinary gain or loss.
Exceptionally, bonds, debentures, notes, or Other certificates of indebtedness issued
by any corporation or by the government are considered ordinary assets by the NIRC
if owned by banks or trust companies. The gain or loss on these debt instruments by
banks or trust companies are deemed ordinary gains or loss.
 Also under the regulations, the real and other properties acquired (ROPA) bybanks,
although they are not involved in the realty business, are considered ordinary assets.
Hence, gain or loss on sale of banks of their ROPA is an ordinary gain or ordinary loss.
DEALINGS IN PROPERTIES
Tax Treatment of Capital Gains and Losses
Under the NIRC, capital losses are deductible only up to the extent of capital gains from
dealings in capital assets other than domestic stocks and real properties. Hence, capital
gains and capital losses are offset.
A net capital gain is an item of gross income subject to regular income tax. A net capital
loss is not an item of deduction against gross income. The law views net capital losses as
unnecessary expenses since capital assets are not used in the business or trade of the
taxpayer.

Determination Of net capital gain or net capital loss

The determination of net capital gains or net capital loss on capital assets, other than
domestic stocks and real properties, depends upon whether the taxpayer is an individual
or a corporation.
DEALINGS IN PROPERTIES
For Individual taxpayers:
The holding period rule
If the capital asset is held by an individual taxpayer for a period of:
1. not more than one year (short-term holding period) — 100% of the
capital gain or loss is recognized
2. more than one year (long-term holding period) — 50% of the capital
gain or loss is recognized

For Corporate taxpayers:

Regardless of the length of the holding period, 100% of the capital gain or
capital loss is recognized. The holding period rule does not apply to
corporations.
Illustration 1
Mr. A, a self-employed resident citizen, reported P800,000 gross receipt and P300,000 cost of services
before business expenses of P240,000. He also had the following dealings in properties during the year:

Dealings in Properties Holding Period Gain(Loss)

Ordinary Assets
Equipment 8 months P 20,000
Old machines 18 months (25,000)

Capital Assets
Foreign bonds 4 months P 100,000
Domestic bonds 15 months (150,000)
Domestic stocks 8 months 80,000
Foreign stocks 18 months 40,000

Required:
1. How much is the net capital gain?
2. How much is the taxable income of Mr. A and his income tax due?
3. Assuming Mr. A is a corporation, how much is the taxable income and the income tax due?
DEALINGS IN PROPERTIES
Effects of Situs on Dealings in Properties
If the taxpayer is taxable on world income such as in the case of resident citizens and
domestic corporations, the rules of dealings in properties apply to all properties regardless
of the location. However, if the taxpayer is taxable only on Philippine income, the rules of
dealings in properties apply only to properties located in the Philippines.

Net Capital Loss Carry over

Individual taxpayers are allowed to carry-over net capital loss as a deduction against net
capital gain of the following year subject to the following limits:
1. Limit 1 - The amount of net income in the year the met capital loss was sustained, and
2. Limit 2 - The available net capital gain in the following year
Hence, the amount of the net capital loss carry-over shall be whichever is the lowest of the
actual net capital loss, Limit 1 and Limit 2.
The net capital loss carry-over is strictly for one year only and is applicable only to
individual taxpayers. Corporate taxpayers are not allowed under the NIRC to carry over net
capital loss.
Illustration 2
Mr. A reported the following in 2018 and 2019:
2018 2019
Net income before dealings in properties P 70,000 P 300,000
Dealings in ordinary assets:
Ordinary gains P 40,000 P 30,000
Ordinary losses ( 80,000) (50,000)
Dealings in capital assets:
Capital gains P 20,000 P 80,000
Capital losses ( 60,000) (30,000)
Net capital gains or (loss) P 40,000 P 50,000
The net income before dealings in capital assets should be determined first. Thu*

Required: How much is the net capital gain and net income subject to tax for 2019?
SPECIAL RULES IN THE
DETERMINATION OF TAX BASIS
A. For assets acquired by purchase, the tax basis is the:
1. Acquisition cost for:
• capital assets
• non-depreciable ordinary assets such as land
• any asset purchased for an inadequate consideration or those acquired at less than
their fair value at the date of acquisition
2. Depreciated cost for depreciable ordinary assets
Acquisition easts include the purchase price, tax assumed, and acquisition-related costs
such as commissions paid in acquiring the asset
B. Other assets received by exchange, fair value of asset received
C. For assets received by way of gratuitous title:
1. 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 or
b. fair market value at the date of gift (Sec 40 (B)(3), NIRC)
If the basis is greater than the market value of the property at the time of donation, then
for purposes of determining the loss, the basis shall be such market value.
2. Inheritance - fair value of the property on the date of death of the decedent.
SPECIAL RULES IN THE
DETERMINATION OF TAX BASIS
D. For shares received by way of tax-free exchanges
a. For pure share- for-share swap, the tax basis of the shares exchanged or given is the
tax basis of the shares received
b. For share-swap with non-cash consideration, the tax basis shall be the substituted
basis computed as follows:
Transferor
Tax basis of shares exchanged P xxx
Add: Gain recognized xxx
Amounts treated as dividends of the shareholder xxx
Less: Cash and fair value of other properties received xxx
Tax basis of new shares received by the transferor P xxx

Properties received as 'boot' shall have the same basis astheir fair market value. Boot
refers to the money received and other property received in excess of the stocks or
securities received by the transferor on a tax-free exchange.
SPECIAL RULES IN THE
DETERMINATION OF TAX BASIS
Transferee
Original basis in the hands of the transferor P xxx
Add: Gain recognized ta the transferor xxx
Tax basis of the shares received by the transferee xxx

The rules on tax basis Of stocks received pursuant to a plan of merger or consolidation
under capital gains taxation are also relevant to regular income tax for the determination of
the substituted basis of:
a. Stocks, domestic or foreign. received by dealers in securities pursuant to a plan of
merger or consolidation
b. Foreign Stocks received by non-dealers in securities pursuant to a plan of merger or
consolidation
TAX FREE EXCHANGES
1. Merger and consolidation
2. Initial acquisition of control

MERGER on CONSOLIDA TION

No gain or loss shall be recognized if in pursuant to merger or consolidation:
1. A corporation exchanges property solely for the stock of another corporation.
2. A shareholder exchanges his stock in a corporation solely for the stock of another
corporation.
3. A security holder or a corporation exchanges his securities in such corporation solely
for the stocks of another corporation.
Both corporations in the aforementioned cases must be parties to a merger or consolidation.
A merger occurs when one corporation acquires all or substantially all of the properties of
another corporation. A consolidation occurs when two or more corporations merged to form
one corporation. The term "securities" includes bonds or debentures but does not include
notes of whatever class or duration.
"Substantially all the properties of another corporation" means the acquisition by one
corporation of at least 80% of the assets, including cash, of another corporation which has
the element of permanence and not merely momentary holding. (BIR General Circular No.
V-253 July 16, 1957)
TAX FREE EXCHANGES
INITIAL OF CORPORATE CONTROL
No gain or loss shall be recognized if property is transferred to a corporation by a person in
exchange for the stocks 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, Provided that stocks issued for services shall not be
considered as issued in return for property.

Taxable Exchanges
1. Share-for-share swap transactions or property-for-share transaction that are not in
pursuant to a plan of merger or consolidation are taxable. Losses are recognized
subject to the applicable tax rules.
2. Transfer of properties to a corporation alone or with four others which did not result in
the acquisition of corporate control.
3. Transfer of properties to a controlled corporation after the initial acquisition of control is
taxable. Losses are non-deductible since the transferee is a related party to the
transferor.
EXCHANGES NOT PLAINLY FOR STOCKS
The exemption rule to stockholders on share-for-share swap and to security holders on
security-for-share swap both pursuant to a plan of merger or consolidation proceeds from
the theory that there is no realization. The shareholder or security holder is still part of the
same corporate entity and the transaction merely involves a replacement of stocks or
securities by stocks. Hence, here is no realization of income.

However, if the transferor received considerations other than stocks in the exchange, gains
but not losses shall be recognized to the extent of cash and/or properties received.

Effect of split and stock dividends on tax basis of stocks

The tax basis of stocks previously held should be spread over the total shares held
following a share split or stock dividend declaration.
EXCHANGES NOT PLAINLY FOR STOCKS
Gain on sale of indebtedness with maturity of more than 5 years
Under Sec, 32(B)(7)(g) Of the NIRC, gains realized from the sale, exchange or retirement of
bonds, debentures or other certificate of indebtedness with a maturity of more than five
years is exempt from income tax. Hence, any capital gain or ordinary gain in dealings in
bonds, debentures, or other certificate of indebtedness with a maturity of more than five
years shall not be subject to income tax.

Properties sold for less than adequate consideration

The excess of the fair market value over the selling price shall be deemed a gift subject to
transfer tax. The difference between the selling price and the tax basis of the property shall
be accounted for as gain or loss.

Capital Gains and Losses Of a General Professional Partnership

Under the NIRC, the net income of partnership shall be determined similar to corporations.
Hence, the rules on dealings on capital assets by corporations apply to partnership
including a general professional partnership,

Sale of properties with excess mortgage assumed by the buyer

If the amount Of the indebtedness assumed by the buyer exceeds the tax basis of the
property disposed of, any consideration received including the excess of mortgage over the
basis of the property sold constitutes gain.
WASH SALES
The wash sales rules discussed under Capital Gains Taxation also apply to the regular
income tax particularly to sale by non-dealers of securities of:
a. Foreign shares
b. Debt securities, foreign or domestic

Wash sales occur when within 30 days before and 30 days after the date of disposal of
securities at a loss, known as the "61-day period", the taxpayer acquired or entered into a
contract or option to acquire substantially identical securities.

Substantially identical securities means securities with the same features. Preferred stocks
and common stocks are not substantially identical. A participating preferred stock and a
non-participating preferred stock are not substantially identical. Bonds with different lengths
of maturities or with different interest rates are also not substantially identical.

The gains from a wash sales transaction are taxable, but the losses are not deductible. The
wash sales rule is not applicable to dealers in securities.
TRANSACTIONS CONSIDERED EXCHANGES
The following are subject to the rules of dealings in properties:
1. Retirement of bonds, debentures, notes, or certificates and other evidence of
indebtedness
The amount received by the holder upon retirement of the indebtedness is deemed received
in exchange thereof.

2. Short sale of properties

Short sale is a sale by a speculator of securities borrowed in anticipation of a decline in
security value. When the security price falls, the speculator gains by buying at the lower
price and replacing the borrowed securities he sold.

3. Failure to exercise a privilege or option to buy or sell property that is a capital

asset
Loss for failure to exercise an option is not an expense, but a capital loss deductible against
capital gain. However, the gain or loss realized by security dealers from trading stock
options is an ordinary gain or loss.
TRANSACTIONS CONSIDERED EXCHANGES
4. Security becoming worthless
This occurs when the issuer of a debt or equity security becomes bankrupt such that none
is recoverable by the investor. Decline in market value is not considered worthlessness.
As a rule, loss on securities becoming worthless is a capital loss. However, for banks, trust
companies and dealers in securities, the same is an ordinary loss deductible as "bad debts
expense."

5. Receipt of liquidating dividends

Liquidating dividends is viewed as consideration in exchange for the investment of the
investor-shareholder, The difference between the proceeds of the liquidating dividends and
the cost of the investment is a capital gain or loss which is subject to the rules of regular
income tax and not to the 15% capital gains tax. (Sec. 8 of RR6-2008)

6. The amount received in liquidation of a partnership is also deemed in exchange

of the partner's interest on the partnership
It should be noted that for a business partnership, the resultant capital gain or loss from
such liquidation is subject to capital gains tax. The capital gain or loss from the liquidation of
a general professional partnership is subject to regular income tax.
TRANSACTIONS CONSIDERED EXCHANGES
7. Redemption of shares for cancellation or retirement by a corporation is considered
exchange to an investor, but not to the redeeming corporation.
Under RR6-2008, the gain on the redemption of its own stocks by a domestic corporation
for the purpose of cancellation is not subject to the capital gains tax. Hence, gain or lass
realized by the investor from the buy-back of corporate stocks, domestic or foreign, shall be
subject to regular income tax.

8. Voluntary buy-back of shares to be held in treasury is considered exchange to the

investor. but not to the corporate issuer of the shares.
Gains or losses on voluntary share buy-back by the issuing corporation which is not for the
purpose of cancellation shall be subject to the capital gains tax in cases of domestic stocks
but to regular income tax in cases of foreign stocks.
Questions to Ponder

1. Compare ordinary assets with capital assets.

2. Discuss the rules of taxation of gains and losses on ordinary assets and other capital assets.
3. What is selling price?
4. Enumerate and discuss the rules on tax basis.
5. How do the rules on individual taxpayers and corporate taxpayers differ as to the measurement of the
net capital gain or loss? Explain.
6. Discuss the basis of the 50% rule on other capital assets held long-term by individuals.
7. Explain the limits on the carry-over of capital loss.
8. At what particular securities are the rules Of wash sales- relevant to regular income tax?
9. Discuss the rules on tax-free exchanges relevant to regular income tax.
10. Discuss how gain is recognized in tax-free exchanges and how basis is determined for the transferor
and the transferee.
11. Enumerate the transactions considered exchanges.
Required Readings

Chapters 12, pp. 393 – 418:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay, Pasay
City, Philippines.
Learning Activities

Chapters 12, pp. 419 – 432:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay, Pasay
City, Philippines.
References

Chapters 12, pp. 393 – 418:

Banggawan, Rex B. 2019. INCOME TAXATION LAWS, PRINCIPLES, AND

APPLICATIONS. Real Excellence Publishing., Pasay Default Barangay, Pasay
City, Philippines.
 Appendix: Course Materials Evaluation
Adopted: BEST PRACTICES AND SAMPLE QUESTIONS FOR COURSE EVALUATION SURVEYS. Retrieved from
https://assessment.provost.wisc.edu/best-practices-and-sample-questions-for-courseevaluation-surveys//.