DEALINGS IN PROPERTY

Lesson 12
Dealings in properties involve the sale, exchanges, and other disposition of properties such as
ordinary assets or capital 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 capital loss.

Determination of Gains or Losses in Dealings in Properties

Selling price PXXX
Less: Tax basis or adjusted basis of the asset disposed XXX
Gain or loss PXXX
Selling price
This 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
Tax basis
This refers to the cost, carrying amount, or depreciated cost of an asset.
Tax Treatment
Ordinary gains are separate items in 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 gains are taxable in full. Ordinary losses are 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 gain 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, gain or loss on sale of banks
of their ROPA is an ordinary gain or ordinary loss.
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. A net capital gain is an item of gross
income subject to regular tax. A net capital loss is not an item of deduction against gross income.
Determination of net capital gain or net capital loss
This depends of whether taxpayer is an individual or a corporation
Determination of net capital gain or net capital loss -
1. Individual taxpayers
The holding period rule:
If the capital asset is held by the 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

2. 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.
Presentation in the Income Tax Return
The reportable gains and losses shall be presented in the income tax return as follows:
Net Sales/Revenues/Receipts/Fees XX
Add: Other Taxable Income from operation XX
Total sales/revenues/receipts/fees XX
Less: Cost of sales or services XX
Gross income from operations XX
Add: Non-operating taxable income:
Ordinary gain XX
Net capital gain XX XX
Total gross income XX
Less: Allowable deductions
Business expenses XX
Ordinary loss XX XX
Taxable net income XX
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 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 income 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
In other words, the amount of the net capital loss carry-over shall be whichever is the lowest of the actual net
capital loss, Limit , and Limit2.
The capital loss carry-over is for one year only and is applicable only to individual taxpayers.

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 costs 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 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 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

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

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 or consolidation
No gain or loss shall be recognized if in pursuant to a merger or consolidation:
3. A corporation exchanges property solely for the stock of another corporation.
4. A shareholder exchanges his stock in a corporation solely for the stock of another corporation
5. A security holder of 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 do not include notes of
whatever class or duration.
Substantially all of 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 holding.

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.

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 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, there is no
realization of income.
However, if the transferor received consideration other than stocks in the exchange, gains but not
losses shall be recognized to the extent of cash and/or properties received.
Gains classification and taxability
The gain shall be classified and subject to tax as follows:
If individual taxpayer is a

Corporation is a Dealer in stocks Non-dealer in stocks

Domestic corporation Ordinary gain subject to regular Capital gain subject to the 15%
income tax capital gains tax
Foreign corporation Ordinary gain subject to regular Capital gain subject to holding
income tax period rule under regular income
tax
Gain on sale of indebtedness with maturity of more than 5 years
Under NIRC, gains realized fro 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 the partnership shall be determined similar to corporations.
Hence, the rules on dealings on capital assets by corporation apply to partnership including 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
These 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 enter 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 non-participating
preferred stock are not substantially identical. Bonds with different lengths of maturities or with
different interest rates are also not substantially identical.
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 s capital loss deductible from capital
gain. However, the gain or loss realized by security dealers from trading stock options is an ordinary
gain or loss.
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 worthless.
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.
6. The amount received in liquidation of a partnership is also deemed in exchange of the
partner’s interest on the partnership
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.
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 loss realized
by the investor from the but-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.