CHAPTER 10

DEALINGS IN PROPERTIES

Learning Objectives:
After this chapter, readers are expected to 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
5. Comprehend the rules on tax-free exchanges on recognition of gain or loss and the determination of basis
of stocks received in
6. Master the rules on wash sales as they relate to capital losses subject to the rules of regular income tax
7. Be able to interrelate the rules of regular income tax to the rules of capital gains tax
8. Familiarize themselves with the list of transactions considered as exchanges

DEALINGS IN PROPERTIES
Involve the sale, exchanges, and other disposition of properties such as ordinary assets or capital assets.

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

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. Advanced rules on tax basis are discussed later in this chapter.

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. 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) by banks, although they are not
involved in the realty business, are considered ordinary assets. Hence, gains or loss on sale of banks of their
ROPA is an ordinary gain or ordinary loss.

Tax Treatment of Capital Gains and Losses

Under 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

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.

Rationale of the holding period rule

Capital Gains normally build up over time. However, the annual capital gain build up is not taxed because they
are unrealized gains. In accordance with the ability to pay theory, these gains are taxable only when realized
or severed from the capital through disposal by sale or exchange.

Effect of Situs on Dealings in Properties

Taxpayer is taxable on world income = rules of dealings in properties applies to all regardless of location.
Taxpayer is taxable in the Philippines only = rules of dealings in properties apply to properties within.

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 net capital loss was sustained, and
2. Limit 2 - The available net capital gain in the following year
Whichever is the lowest of the actual net capital loss, Limit 1, and Limit 2. Applicable for one year only.
Corporate Taxpayers are not allowed under NIRC to carry over net capital losses.

Special Rules in the determination of tax basis

A. For assets acquired by purchase, the tax basis is the:
1. Acquisition cost for:
a. Capital assets
b. Non-depreciable ordinary assets such as land
c. Any asset purchased for an inadequate consideration or those acquired at less than fair value at the
date of acquisition
2. Depreciated cost for depreciable ordinary assets
-Acquisition cost include the purchase price, tax assumed, and acquisition-related cost such as commissions
paid in acquiring the asset.

B. Other assets received by exchange, fair value of the 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
2. Inheritance - fair value of the property on the date of death of the decedent

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 P xxx
Amounts treated as dividends of the shareholder P xxx
Less: Cash and fair value of other properties received P xxx
Tax basis of new shares received by the transferor P xxx

Transferee
Original basis in the hands of the transferor P xxx
Add: Gain recognized to the transferor P xxx
Tax basis of the shares received by the transferee P xxx

TAX FREE EXCHANGES

1. Merger or Consolidation
2. Initial acquisition of control
Merger or Consolidation
No gain or loss shall be recognized if in pursuant to a 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 of a corporation exchanges his securities in such corporation solely for the stocks of
another corporation

Initial acquisition 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.