May 2021

GAIN OR LOSS FROM SALE OR EXCHANGE OF PROPERTY

Atty. C. Llamado

Sale or exchange of properties are classified into:

1. Sales resulting to Capital Gains (subject to “CGT”)

a) On the sale of domestic shares.

b) On the sale of real property classified as capital assets.

2. Tax-Free Exchanges – where No Gain nor 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

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.
c) Illegal 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 xxxx
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
is computed as follows:

FMV of the property received xxxx

Less: Basis of property given (xxx)
Gain (Loss) xxxx

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May 2021

BASIS

a) If property 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 acquired 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.

d) If property was acquired for less than an adequate consideration, the basis of the property
is the amount paid.

e) 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 xxxx

Plus: Improvements xxxx
Less: Accumulated Depreciation (xxx)
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.
c) Gain or loss in the sale of domestic shares not traded in the stock exchange.
d) 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
e) Gain or loss in the sale of real property classified as capital asset of an RFC or NRFC.

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May 2021

CLASSIFICATION OF PROPERTIES FOR TAX PURPOSES

Ordinary Assets Capital Assets

a) Stock included in inventory; Asset which is not an ordinary asset, such as:
b) Property primarily held for sale; (1) personal or non-business property or
c) Property used in business which (2) asset held merely for investment, or
is capitalized; (3) property not used in business
d) Real property used in the trade,
business, or profession of the
taxpayer

How taxed? How Taxed?

Gain is 100% included in the ITR. Sale of (a) domestic Sale of capital assets other than
shares held as capital domestic shares held as capital assets,
Loss is 100% deducted in the ITR if assets; (b) real properties or RPCAs.
taxpayer itemizes deductions. in the Philippines
classified as capital
assets (RPCA)
Subject to FTs: Gain/Loss (“G/L”) is recognized,
but only Net Capital Gain is
1) Capital gains tax on included in the ITR:
sale of domestic
shares; 1) If taxpayer is an individual:
2) Capital gains tax on
sale of real property ST1 G/L = 100% recognized
located in the LT2 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 as a 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.

1
Short-term – holding period of taxpayer is not more than 1 year.
2
Long-term – holding period of taxpayer is more than 1 year.

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May 2021

Other Transactions Resulting in Capital Gains or Losses Where There is

NO SALE

1) When stocks or bonds held as capital assets become worthless, capital loss is recognized.

2) When bonds (held as capital assets) are retired.

3) Gains or losses from failure to exercise options (option gains or losses).

4) When the assets of a corporation are distributed in complete liquidation thereof

(liquidating dividend). Capital gain or loss to the shareholder is recognized.

5) Redemption of preferred shares.

6) 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)

7) 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.
c) 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 loss on the wash sale is a capital loss, but is not
deductible against capital gains.

Formula for Non-Deductible Loss:

No. of Shares Acquired Within 61 day period x Loss = Non-deductible Loss

No. of Shares Sold

Formula for Tax Basis of Re-Acquired Shares:

Cost of Acquisition xxxx

+ Non-deductible Wash Sale Loss xxxx
New Tax Basis/Cost xxxx
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May 2021

TAX-FREE EXCHANGES OF PROPERTIES PURSUANT TO A MERGER OR

CONSOLIDATION (CORPORATE REORGANIZATION)3

(1) IF in pursuance of a plan of merger or consolidation:

(a) A corporation (transferor), which is a party to a merger or consolidation, exchanges

property solely for stock4 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 stock5 of another corporation also a party to the
merger or consolidation; or

(c) A security holder (transferor), of a corporation, which is a party to the merger or

consolidation, exchanges his securities in such corporation, solely for stock6 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 stock7 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) persons8, gains control of said
corporation.

Tax Consequences:

(1) The Transferor shall NOT recognize gain or loss (i.e., no CGT, no regular income
tax, no CWT, no donor’s tax, no VAT9); 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 ₱5 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 ₱7 per share.

(a) What is the gain of Marian?

Fair market value of Y shares received (₱7 x 500 shares) ₱ 3,500

Less: Basis in X shares transferred (₱5 x 100 shares) (500)
Gain ₱ 3,000

However, this gain will not be recognized and therefore is not taxable.

3
Sec. 40(C)(2), NIRC.
4
Whether voting or non-voting.
5
Whether voting or non-voting.
6
Whether voting or non-voting.
7
Voting.
8
The 4 other persons must also be transferors of property.
9
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).

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May 2021

(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 = ₱1/share x 500 shares =
₱500.

(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 ₱ 20,000

Less: Basis (₱1 x Y 500 shares) (500)
Gain ₱ 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 ₱ xxxx

Less: (a) Money received ₱ xxxx
(b) FMV of property received xxxx (xxx)
Balance ₱ xxxx

Add: (a) Gain recognized on the exchange ₱ xxxx

(b) Amount treated as dividend xxxx xxxx

Basis (Cost) of the stock received ₱ xxxx

Example: In the previous example, pursuant to a merger Marian exchanged her 100 X shares for
500 Y shares (FMV = ₱7 per share) plus land (FMV = ₱5,000) and ₱2,000 in cash.

(a) How much gain shall Marian recognize? ₱7,000

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May 2021

Fair market value of Y shares received (₱7 x 500 shares) ₱ 3,500

Plus: Boot: Land 5,000
Cash 2,000 7,000
10,500
Less: Basis in X shares transferred (₱5 x 100 shares) (500)
Gain ₱ 10,000

But, Gain to be recognized shall not exceed the boot received in the amount of
₱7,000.

(b) What will the basis of the Y shares of Marian? ₱500

Cost (basis) of the X shares transferred ₱ 500

Less: (a) Money received ₱ 2,000
(b) FMV of land received 5,000 (7,000)
Balance ₱ (6,500)
Add: Gain recognized on the exchange 7,000
Basis (Cost) of the Y shares received ₱ 500

(c) What is the basis of the land received in the hands of Marian? ₱5,000