Group 8

D EA LI NG S I N
PROPERTIES

Chapter 12
Dealings i n Properties: A n Overview

This chapter discusses tax rules on the

measurement and recognition of gains and losses
arising from dealings in properties not subject to
capital gains tax but subject to the regular income
tax.
 Dealings in properties
involve in the sale,
exchanges, and other
DEALINGS I N
disposition of
PROPERT I ES
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 asset 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.
D e t e r m i n a t i o n o f Gains o r L o s s e s i n D e a l i n g s i n
Properties

Selling price P xxx

Less: Tax basis or
adjusted basis xxx
o f the asset disposed
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 o f money received and

2. Fair value o f non-cash properties
received
 W h a t i s t a x 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.
 Ta x Tr e a t m e n t o f O r d i n a r y Gains a n d
Lossess

Ordinary gains are seperate 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
 T a x T r e a t m e n t o f C a p i t a l Gains a n d
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 income tax

A net capital loss is not an item of deduction against

gross income.
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.
 For I n d i v i d u a l t a x p a y e r s
Theholding 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 1 year (long term holding period)- 50%
of the capital gain or losz is recognized.
 for Corporate
taxpayers:
100% of the capital gain or loss is recognized.
the holding period rule does not apply to
corporations.

Illustration: Individual taxpayer

Mr. Manila sold various properties as follows
in 2021
 Illustration:
Co r p o r a t i o n

Bataraza Corporation, a domestic shipbuilding

company, assigned its receivable to the bank without
recourse at a loss of 200,000. During the year, it
disposed an old building at a gain of 800,000 and
its investment in foreign securities at a gain of
350,000. All assets were held for more than one
year.
 Int egrat ive
Illust rat ion

Mr. Pantukan, a self-employed resident citizen,

reported 800,000 gross receipts and 300,000 cost
of services before business expenses of 240,000.
He also had the following dealings in properties
during the year.
 Rationale of the
h o ld i n g p e r i o d r u le
C a p i t a l g a i n s n o r m a l l y b u i l d u p o v e r t i m e . H o w e v e r, t h e a n n u a l
capital gains build up is not tax ed because they are unrealized
g a i n s . I n a c c o r d a n c e w i t h t h e a b i l i t y t o p a y t h e o r y, t h e s e g a i n s
are taxable only w h e n realized or severed from the capital
through disposal by sale or exchange.

Individual taxpayers are subject to progressive t a x where higher

income is subject to higher t a x and lower income to lower tax. As
a legislative compromise, only 50% of long-term capital gains and
losses upon disposal are recognized for taxation purposes.
Corporate taxpayers are subject to a proportional
or flat tax rate regardless of the level of
income. The one-time taxation of the gain on
disposal and the annual taxation of the capital
gain as it builds up over time will yield the same
amount of tax. Thus, the holding period rule is
held not to apply to corporate taxpayers
 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.
Illustration1
John Hampton, a Filipino citizen, reported the following gains and
(losses) from dealings in properties:
I l l u st r a t i o n 2
Th e r e p o r t a b l e r e su l t s o f d e a l i n g s
in propertiesare as follows:
 N e t C a p i t a l L o s s 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
 Illustration 1
Mr. Quintey reported the following in 2013 and 2014:
The net income before dealings in capital assets
should be determined first. Thus,
The net capital gain in 2014 shall be computed as
follows:
The net income for each year shall be computed as:
 Illustration 2
An individual taxpayer had the following net capital
gains or losses:
The net capital gain in 2014 shall be computed as follows:
The net income for each period shall be:
oR a t i o n a l e o f t h e f i r s t l i m i t : N e t I n c o m e a t
Incurrence of Capital Loss
oR a t i o n a l e o f t h e s e c o n d l i m i t : N e t C a p i t a l
gain in the following year
 SPECIAL RULES I N THE DETERMINATION
OF T A X BASIS

1. Acquisition Cost, for:

o Capital Assets
oNon-depreciable ordinary assets such as land
o 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
 I l l u s t r a t i o n : Gain o r l o s s m e a s u r e m e n t o n
depreciable assets

Veruela Corporation disposed its old factory for

P5,000,000. The lot where the factory building stands
were acquired 10 years ago at P1,500,000 Veruela
Corporation paid P3,000,000 for the construction of the
factory building. The factory building has a carrying
value net of accumulated depreciation of P1,200,000 at
the date of sale.
The tax basis of the factory shall be:
Hence, the gain or loss shall be:
 Illustration: Other capital assets

Mr. Monkayo purchased a car he believes would be useful

for 10 years for P800,000. Before the third year, he
sold the car for P900,000. Note that the tax basis of
capital assets is their acquisition cost Capital assets
are not depreciated for purposes of taxation. The gain
on the sale shall be P100,000, computed as P900,000 less
P800,000 tax basis.
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
 I l l u s t r a t i o n 1: D o n a t i o n
Mr. Calaponga received a Volkswagen car as donation
from his brother who bought the same in 1990 at a cost
of P100,000. The car has a fair value P 1,000,000 at the
date of deimation but have current fair value of
P1,500,000
The last preceding owner who did not acquire the
property by donation acquired the same at P100,000.
Hence, the basis of the car in the hands of Mr. Calap
shall be that came bats, thus P100,000
 I l l u s t r a t i o n 2: I n h e r i t a n c e

Mr. Siasi inherited a used school bus from his

deceased
grandfather who purchased the P1,000,000 3
years ago. The bus has a depreciated basisfor
property of P800,000 in
the business of his grandfather but has a fair value of
P900,000 in the estate tax return of his
grandfather.
The basis of the property in the hands of Mr. Siasi shall
be P900,000, the fair value on the date of death of the
decedent.
 I l l u s t r a t i o n 3: D o n a t i o n a f t e r i n h e r i t a n c e

Assuming further that Mr. Siasi donated the bus to a

school, what is the basis of the bus to the school?
The basis of the bus shall be the basis in the hands of
the last preceding owner who did not the property by
acquire
donation. Mr. Siasi acquired the property by
inheritance at a basis of P900,000. Hence, the same amount
shall be the basis of the bus in the hand of the school.
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

Properties received as 'boot' shall have the same basis as their 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.
Transferee

The rules on tax basis of stocks received in 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
in pursuant to a plan of merger or consolidation
 b. Foreign stocks received by non-dealers in
securities in pursuant to a plan of merger or
corporation
 T A X FREE EXCHANGES

I. Corporate reorganization
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.
 I l l u s t r a t i o n 1: C o r p o r a t e p a r t y t o a m e r g e r o r
consolidation

Pursuant to a plan of merger, ABC Company

exchanges a vast track of land with a fair
value of P12,000,000 and tax basis of
P10,000,000 for the stocks of DEF Company
with a fair value of P12,500,000 and par
value of P11,000,000.
For ABC C o m p a n y

For DEF C o m p a n y
 I l l u s t r a t i o n 2: S h a r e h o l d e r o f a p a r t y t o a m e r g e r
or consolidation

Mr. Downy is a shareholder in ABC Company

which is merging with DEF Company. Mr. Downy
was required to surrender his ABC shares with
tax basis of P100,000 and fair value of
P120,000 in exchange for DEF shares with a
fair value of P140,000
I l l u s t r a t i o n 3: S e c u r i t y h o l d e r o f a p a r t y t o a m e r g e r o r
consolidation

Mrs. Wacky is a holder of bonds of ABC

Company which is merging with DEF Company.
Pursuant to the plan of merger, Mrs. Wacky
was required to exchange her bond investments
costing P400,000 for the shares of DEF
Company worth P500,000.
 I N I T I A L 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 sued for services
shall not be considered as issued in return for
property.
 Illustration 1

Ali exchanged his land and building with tax

basis of P18,000,000 for the stocks of ABC
company with total par value of P15,000,000.
Consequently, Mr. Ali obtained %ownership in ABC
Company.
 Illustration 2

Matthew, Mark, Luke, John, and Peter exchanged

their commercial lands (all ordinary assets) for
the stocks of a corporation where they obtained
total shareholdings 60%. Barnabas also rendered
consultancy services to said corporation and was
granted 10% shareholdings.
 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. Related party rules will be discussed in Chapter
13.
 EXCHANGES NOT PL AIN L Y FOR STOCK
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, there is
no realization of income.
 However, if the transferor received considerations other
than stocks in the exchange, gains but not losses shall be
r e c o g n i z e d t o t h e e x t e n t o f c a s h and/or p r o p e r t i e s
received.
 I l l u s t r a t i o n 1: I n d i c a t e d g a i n e x c e e d s c a s h a n d o t h e r
properties received

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 and P15,000 cash in
exchange for her Aurum Company shares.
The indicated gain is considered realized t o the e x t e n t of
cash received. Any excess Indicated gain is an unrealized
gain. Th u s,
 Gain c l a s s i f i c a t i o n a n d t a x a b i l i t y
The gain shall be classified and subject to tax
as follows:
 Tax basis of the King shares
The tax basis of the King shares received shall be
computed using the regulatory formula as follows:
A l t e r n a t i v e l y , t h i s c a n b e d i r e c t l y c o m p u t e d as:
 Tax basis of Aurum shares to the assignee
The basis of the Aurum shares acquired by King from Ms.
Denver shall be substituted basis computed using the
regulatory formula as follows:
Alternative formula:
Thus,
 I l l u s t r a t i o n 2: Cash a n d o t h e r p r o p e r t i e s r e c e i v e d e x c e e d s
indicated gain
Pursuant to a plan of consolidation, Ms. Denver exchanged her Aurum
shares costing 100,000 for the King shares with fair value of
85,000 plus 20,000 cash. Aurum Company declared a 10% cash dividend
before the merger and the record date of the dividends.
Consequently, Ms. Denver is due to receive 100,000 dividends on the
shares exchanged.
Note that the dividends are effectively acquired by King
Corporation because the share swap is made between the date of
declaration and the date of record, King Corporation will be
registered at the date of record as shareholder and will receive
the dividends on the aurum shares transferred by Ms. Denver at the
date of payment.
The value of any cash or properties received shall be
considered realization of gain t o the e xtent of the indicated
gain. A n y e x c e s s i s a r e t u r n o f a c a p i t a l , Thus,
The 5,000 gain shall be recognized. A loss shall not be
recognized. The 10,000 dividends on the stocks sold
dividend-on shall be reported by Ms. Denver in gross
income subject to the regular income.
Alternative formula:
The basis of the shares received can be alternatively
computed as:
Ta x b a s i s o f A u r u m s h a r e s
The basis of the Aurum shares acquired by King from Ms.
Denver shall be the substituted basis computed using the
regulatory formulas as follows:
Alternative formula:
I l l u s t r a t i o n 3:
Quezon Corporation, not a security dealer, is a
shareholder of ABC Corporation, a foreign corporation,
which will be consolidated with QRZ Corporation, a
domestic corporation. Quezon Corporation acquired its ABC
shares for 200,000
.

Assume that pursuant to the plan of consolidation between

ABC and QRZ, Quezon Corporation exchanged its ABC shares
for:
Case 1: 80,000 c a s h , 5 0 ,0 0 0 w o r t h o f m e r c h a n d i s e , a n d
120,000 w o r t h o f QRZ sh a r e s.

Case 2: 90 ,0 0 0 c a s h , 5 0 ,0 0 0 w o r t h o f m e r c h a n d i s e , a n d
120,000 w o r t h o f QRZ sh a r e s.
The indicated gain and reportable gain shall be computed
as follows:
T h e t a x b a s i s o f t h e s h a r e s r e c e i v e d s h a l l b e c o m p u t e d as:
Tax basis to the assignee
Alternative formula:
Effects of split and s t o c k dividends on t a x basis
of stocks

The tax basis of stock previously held

should be spread over the total shares
held following a share split or stock
dividend declaration.
 Illustration

Mr. Bonuan invested 100,000 in the stocks of

Ilocandia Corporation. A total of 1,000 shares were
acquired at a cost of 100/share. Ilocandia declared a
25% stock dividend. Just before a receipt of the
stock dividend, Mr. Bonuan sold 1,000 shares for
90,000.

Adjusted basis= [100,000/(100,000+25%x100,000)]= 80/share

The gain on disposal shall be computed as follows:
 Gain o n s a l e o f i n d e b t e d n e s s w i t h m a t u r i t y o f
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 shat not be subject to
income tax.
 Property 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.
 C a p i t a l Gains a n d L o s s e s o f a General
Professional Partnership

Under the NIRC, the net income of partnership

shall be determined similar to corporations.
Hence, the rules on dealing on capital asset by
corporations apply to partnership including a
general professional partnership.
 Sale o f p r o p e r t i e s w i t h e x c e s s m o r t g a g e
assumed by 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.
Illustration.
Bohol Corporation sold office building with a tax
basis of 2,000,000 which was encumbered by a
2,500,000 mortgage. The buyer assumed the mortgage
and paid Bohol 200,000.
The gain can be computed as follows:
Alternative, the gain can also be computed in the
usual w a y as follow:
 WASH SALES
Applies to the Regular income tax particularly to
sale by non-dealers of securities of
a. Foreign shares
b. Debt securities, foreign or domestic

REMEMBER!
Wash sale 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 option to acquire substantially identical
securities.
WASH SALE TRANSACTION

Gain-taxable
Losses-not deductible
I l l u s r t r a t i o n 1 : Forei g n s t o c k s
A taxpayer had the following transactions in the shares of
Nitros company, a foreign company on the following date.
 Required: d e t e r m i n e t h e r e p o r t a b l e g a i n s p e r y e a r
assuming that the taxpayer is subject to t a x on global
i n c o m e a n d is:

a. Anindividual non-dealer in securities

b. Anindividual dealer in securities
c. Acorporate non-dealer in securities
d. Acorporate dealer in securities
 Taxpayer is an individual, not a dealer in s t o c k s
Both the wash sale rule and the holding period rule apply.
The 10,000 loss in july 15, 2020 for the sale of 5,000
shares is preceded by a purchase of 3,000 shares within the
61-day period

Deferred loss (3,000/5,000 x P10,000) P6,000

Realized loss (2,000/5,00 P10,000) 4,000
Loss 0x P10,000
 T h e b a s i s o f t h e s h a r e s p u r c h a s e d o n J u n e 18, s h a l l b e
adjusted as follows:

Purchase cost P 51,000

Add: deferred loss on wash sale 6,000
Adjusted basis P57,000
 T h e O c t o b e r 1, 2 0 2 1 g a i n s h a l l b e a d j u s t e d f o r t h e
d e ff e r e d l o s s a d j u s t e d t o t h e b a s i s o f t h e s t o c k s b o u g h t o n
j u n e 18:

October1, 2021 gain P 50,000

Less: increase in basis of shares sold 6,000

Gain to recognize on October 1, 2021 P 44,000