Module No.

5 – Dealings in Properties

Learning Outcome/s:
Understand the classifications of and tax rules for properties

Core Values/Biblical Principles:

To be accountable means to be reliable and to be responsible for one’s decisions. Accountability
eliminates the time and effort one spends on distracting activities and unproductive behavior. When
people in the workplace are accountable for their actions, they value their work and productivity is
increased.

Introduction:
Dealings in properties involve the sale, exchange and other disposition of properties such as ordinary
assets and capital assets. It should be recalled that ordinary assets are those used in business while
capital assets are assets other than ordinary assets. Dealings in ordinary assets may result to ordinary
gain or loss while dealings in capital assets may result to capital gain or loss.

Body:
Sale or exchange of properties are classified into:
1. Sales resulting to capital gains subject to capital gains tax (i.e., sale of domestic stocks and real
properties classified as capital assets)
2. Tax-free exchanges where no gain or loss is recognized (i.e., pursuant to merger or
consolidation)
3. Sales or exchanges where gain, but not loss, is recognized (i.e., exchanges not solely in kind
pursuant to corporate reorganization where boot is received, transactions between related
persons under Section 36 (B) of the Tax Code, and illegal transactions)
4. a. Sale or exchange of ordinary assets
b. Sale or exchange or other capital assets

 If the transaction is a sale, the gain or loss to be recognized is computed as follows:

Sale Php xxx
Less: Basis xxx
Gain/loss Php xxx

 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 Php xxx
Less: Basis of the property given xxx
Gain/loss Php xxx

Basis:
a. If property was acquired by purchase – cost
b. If property was acquired by inheritance – FMV of the property at the time of death of
decedent
c. If property was acquired by gift – lower of FMV at the time of the gift and basis in the
hands of the donor
d. If property was acquired for less than adequate consideration – amount paid
e. If property was acquired in a previous tax-free exchange where gain or loss is not
recognized – 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.
Basis of the property Php xxx
Plus: Improvements xxx
 Less: Accumulated depreciation xxx
Adjusted basis Php xxx

Classification of Properties for Tax Purposes

1. Ordinary assets
Tax treatment – Gain is 100% included in the income tax return (ITR)
Loss is 100% deducted in the ITR if taxpayer itemizes deductions

2. Capital assets
Tax treatment:
a. Subject to final tax (CGT) – CGT on sale of domestic stocks
CGT on sale of real property located in the Philippines
b. Capital assets other than the above – gain or loss is recognized but only net capital gain is
included in the ITR
 If taxpayer is an individual – Short term gain or loss is 100% recognized
Long term gain or loss is 50% recognized
 If taxpayer is a corporation – gain or loss, whether short term or long term, is 100%
recognized
 Short-term holding period – one year or less
c. Capital losses are allowed only against capital gains.
d. Net capital loss carry-over – any net capital loss of an individual taxpayer can be carried over
to the next succeeding year as a short-term net capital loss, but not to exceed the net
income in which the capital loss was incurred. (Note: Corporate taxpayers are not allowed
any net capital loss carry-over.)

Illustration
A resident citizen reported Php 1,000,000 gross receipts and Php 400,000 cost of services before
business expenses of Php 250,000. He also had the following dealings in properties during the year.
Properties Holding period Gain/(loss)
Ordinary assets
Equipment 8 months Php 20,000
Old machines 18 months (25,000)
Capital assets
Foreign bonds 4 months 100,000
Domestic bonds 15 months (150,000)
Domestic stocks 8 months 80,000
Foreign stocks 18 months 40,000

Foreign bonds (100,000 x 100%) Php 100,000

Domestic bonds (-150,000 x 50%) (75,000)
Foreign stocks (40,000 x 50%) 20,000
Net capital gains Php 45,000

The net capital gains or losses shall be presented in the income tax return as non-operating taxable
income or allowable deductions, respectively. Ordinary gains shall likewise be reported under non-
operating taxable income while ordinary losses shall be reported under allowable deductions.

Illustration
Assume instead that the taxpayer on the previous illustration is a corporation.
Foreign bonds (100,000 x 100%) Php 100,000
Domestic bonds (-150,000 x 100%) (150,000)
Foreign stocks (40,000 x 100%) 40,000
Net capital loss Php (10,000)

Illustration
Mr. A reported the following in 2019 and 2020:
Properties 2019 2020
Net income before dealings in properties Php 70,000 Php 300,000
Ordinary assets
Ordinary gains 40,000 30,000
Ordinary losses (80,000) (50,000)
Capital assets
Capital gains 20,000 80,000
Capital losses (60,000) (30,000)
Net capital gains/(loss) Php (40,000) Php 50,000

2019 2020
Net income before dealings in properties Php 70,000 Php 300,000
Ordinary gains 40,000 30,000
Ordinary losses (80,000) (50,000)
Net income before capital assets Php 30,000 Php 280,000

2019 2020
Net capital gain/loss Php (40,000) Php 50,000
Carry-over: Lowest of 30k, 40k, 50k 30,000 (30,000)
Net capital gain Php 20,000

2019 2020
Net income before capital assets Php 30,000 Php 280,000
Add: Net capital gain - 20,000
Net income Php 30,000 Php 300,000

Note: The unused Php 10,000 net capital loss on 2019 can no longer be used in the future periods since
carry-over is allowed only for one year.

Other Transactions Resulting in Capital Gains/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.
7. Gains or losses from short sales.
Short selling – 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.

Tax-Free Exchanges
a. Exchange of stocks pursuant to a merger or consolidation
b. Transfer of stocks resulting in corporate control

Tax consequences of tax-free exchanges:

1. The transferor shall not recognize gain or loss.
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).
3. If the transferor receives not only stock or securities, but also money or property, gain but not
loss shall be recognized.
  Gain recognized is less than or equal to the money and FMV of property received (No
gain is recognized if the transferor is a corporation and the boot is distributed in
accordance with the plan of merger or consolidation.)
 Basis of the shares received by the transferor shall be computed as follows:
Cost (basis) of the stock/property transferred Php xxx
Add: Gain recognized on the exchange Php xxx
Amount treated as dividends xxx xxx
Less: Money received xxx
FMV of property received xxx xxx
Cost (basis) of the stock received Php xxx

Other notes:
 Gains realized from sale, exchange or retirement of bonds, debentures or other certificate of
indebtedness with a maturity of more than five year is exempt from income tax. Any capital gain
or ordinary gain in such dealings shall not be subject to income tax.
 If the properties are 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.

Summary:
Dealings in properties may result to either ordinary or capital gain/loss. It is important to properly
classify the properties whether ordinary assets or capital assets since there are different tax treatments
depending on the type of property transacted.

References:
Income Taxation, Rex Banggawan 2019 Edition