CHAPTER 12: DEALINGS IN PROPERTIES

Dealings in properties involve the sale, exchanges, and other disposition of properties such as
ordinary assets or capital assets.
Ordinary assets are assets used in the business of the taxpayer such as inventories, supplies
and property, plant and equipment. Capital assets are assets other than ordinary 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.
Section 39 (A) of the NIRC specifically provides the classifications of ordinary assets as follows:
1) Stock in trade intended for sale in the normal course of business such as:
a) Merchandise inventory (finished goods, in process and raw materials);
b) Securities held or being sold by dealers in securities
2) Real properties acquired by real estate dealers or developers
3) Properties used in business subject to depreciation provided in Section 34 (F) of NIRC; or
4) Real properties used in trade or business including real property held for rent

Capital Assets – defined by exclusion; these are properties held by the taxpayer but does not
include ordinary assets. Therefore, capital assets are property of a taxpayer other than ordinary
assets. Examples of capital assets are (but not limited to) the following:
1) Stock and securities held by taxpayers other than dealers in securities
2) Interest in partnership and joint venture
3) Goodwill
4) Real and personal properties not used in trade or business like residential house and lot, car,
jewelries, etc.
5) Investment property
Note: the sale of real properties and sale of securities are subject to final taxes. The gain on sale
of capital assets other than real properties and securities is subject to regular income tax

Ordinary loss – Loss incurred from the sale or exchange of ordinary asset. (It also means the
excess of deductions over the gross income of a taxpayer during a taxable year, or net operating
loss).

Net Capital Gain – Excess of the gains from sales or exchanges of capital assets over the losses from
such sales or exchanges.
 Holding Period – Length of time the asset was held by the taxpayer. It covers the period from the
date of acquisition to the date of sale or exchange.
Net Capital Loss – Excess of the losses from sales or exchanges of capital assets over the gains from
such sales or exchanges
Dealers in Securities – All persons, who for their own account are engaged in the sale of stocks,
bonds, exchanges, bullions, coined money, bank notes, promissory notes, or other securities as
licensed by the SEC.
Determination of Gains or Losses
Selling Price Less Tax Basis or adjusted basis of the asset disposed = Gains/(Loss)
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
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.
Tax Treatment of Ordinary Gains and Losses
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 upon whether taxpayer is an individual or a corporation
1. Individual taxpayers; The holding period rule:
 Not more than one year (short-term holding period) – 100% of the capital gain or loss is
recognized.
 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. Holding period rule does not apply to corporations,
Presentation in the Income Tax Return (self-employed resident citizen)
Net sales/Revenues/Receipts/Fees
Add: Other taxable income from operation
Total sales/Revenues/Receipts/Fees
Less: Cost of sales or services
Gross income from operations
Add: Non-operating taxable income
Ordinary gain on equipment
Net capital gain
Total gross income
Less: Allowable deductions
Business expenses
Ordinary loss on old machines
Taxable net income

Presentation in the Income Tax Return (Corporation)

Net sales/Revenues/Receipts/Fees
Less: Cost of sales or services
Gross income from operations
Add: Other taxable income not subject to FIT
Ordinary gain on equipment
Total gross income
Less: Allowable deductions
Business expenses
Ordinary loss on old machines
Taxable net income

Net Capital Loss Carryover

When a net capital loss is incurred in a period, said amount is still not deductible against
ordinary gains/losses. Instead, such amount can be carried over as a deduction for the next taxable
year if there is a net capital gain. The amount which can be carried over is the lowest of:
1. Net Capital Loss ;
2. Net Income in the year the net capital loss is sustained; and
3. Net capital gain in the following year.
Net capital loss carry over is strictly for one year only and is applicable only to individual taxpayers
 Net income before dealings in capital assets = Net income before dealings in properties plus
ordinary gains minus ordinary losses
Net capital gain = Net capital gain or loss minus Carry-over
Net income = Net income before dealings in capital assets plus Net capital gain
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 asset
Acquisition Cost – purchase price, tax assumed, and acquisition-related costs such as
commissions paid in acquiring the assets.
Tax basis for land: cost
Tax basis for other properties: depreciated cost or book value
B. Other assets received by exchange, fair value of asset received
C. For assets received by way of gratuitous title:
1) Donation - w/ever is lower of:
a) 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
Market value is the basis used when basis is greater than market value of the property at the time of
donation, for purposes of determining the loss.
2) Inheritance - Fair value of property on the date of death of 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
Add: Gain recognized
Amounts treated as dividends of the shareholder
Less: Cash and fair value of other properties received
Tax basis of new shares received by the 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
Original basis in the hands of the transferor
Add: Gain recognized to the transferor
Tax basis of the shares received by the transferee
Rules on Tax Basis of stocks received pursuant to a plan of merger or consolidation under CGT
are also relevant to RIT for the determination of the substituted basis of:
a. Stocks, domestic or foreign, received by dealers in securities plan of merger or consolidation
b. Foreign stocks received by non-dealers in securities pursuant to a merger or consolidation
TAX FREE EXCHANGES (same rule in Chapter 6)
1. Corporate reorganization
1: Corporate party to a merger or consolidation
Indicated gain = Fair value of shares received less Tax basis of the land exchanged
No gain or loss shall be recognized for the property-for-stock transaction pursuant do you plan of
merger or consolidation. The law viewed this as an investing transaction.
Excess – Share premium = Fair value of the land received less Tax basis of the stocks exchanged
(par)
2: Shareholder of a party to a merger or consolidation
Indicated gain = Fair value of shares received less Tax basis of stocks exchanged
3: Security holder of a party to a merger or consolidation Indicated gain = Shares received less
Tax basis of bonds exchanged.
2. Initial acquisition of corporate control
No gain or loss shall be recognized if property is transferred to a corporation person in exchange
for the stocks or unit of participation in such a co others which as a result of such: - exchange said
person, alone or together with exceeding four (4) persons, gains control of said corporation. Stocks
issued for services shall not be considered as issued in return of 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 nondeductible since the transferee is a related party to the transfer.
If indicated gain exceeds cash and other properties received
Indicated gain = Shares received plus Cash received = Total consideration received or selling
price less Tax basis of stocks exchanged (cost)
The indicated gain is considered realized to the extent of cash received. Any excess indicated gain is
on unrealized gain. Thus,
Indicated gain = Realized return on capital (to the extent of cash received plus Unrealized gain (in
excess of cash received)
GAIN CLASSIFICATION AND TAXABILITY
Domestic corporation (Dealer in stocks)
Ordinary gain subject to regular income tax
Domestic corporation (Non-Dealer in stocks)
Capital gain subject to the 15% capital gains tax

Foreign corporation (Dealer in stocks)

Ordinary gain subject to regular income tax
Foreign corporation(Non-Dealer in stocks)
Capital gains subject to holding period rule under regular income tax
Effect of split and stock dividends on tax basis of stocks
The tax basis of stocks previously held should be spread over the total shares held following a
share split or stock dividend declaration.
Illustration: Mr. Benguet invested P100,000 in the stocks of Ilocandia Corporation. A total of 1000
shares were acquired at a cost of P100 per share. Ilocandia declared a 25% stock dividend. Just
before the receipt of the stock dividend, Mr. Benguet sold the 1000 shares for P90,000.
Adjusted basis = [P100,000/(100,000+ 25% * 100,000)] = P80/share
Selling price 90,000
Less: Tax basis of shares sold (1000 shares*P80 80,000
Gain on disposal 10,000

Gains realized from the sale, exchange or retirement of bonds, debentures, or other certificate of
indebtedness with maturity of more than five years is exempt from income tax.
Properties sold for less than adequate consideration
Excess of the fair market value over the selling price shall be deemed a gift subject to transfer
tax. Difference between the selling price and the tax basis of the property shall be accounted for as
gain or loss.
 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.
Ordinary gain = Cash received plus Excess of mortgage over cost or tax basis

Wash Sales – sale or disposal of stock or securities where substantially identical securities are
acquired within 61-day period, (beginning 30 days before the sale and ending 30 days after the sale or
disposal of securities at a loss)
Applicable also to the RIT particularly to sale by non-dealers of securities of:
a. Foreign shares
b. Debt securities, foreign or domestic
Gains from a wash sales transaction are taxable but the Losses are not deductible.
Requisites of Wash Sale Loss:
1. The sale of the stock or securities is at loss
2. Within 30 days before or after such sale the seller acquired by purchase or exchange substantially
identical security
3. The seller is not a dealer in stock or securities If the number of securities sold is more than the
number of securities purchased within 61-day period, then:
No loss shall be recognized on the acquisition within 61-day period which are match with the number
of shares disposed of; and
Capital loss shall be recognized on the number of shares disposed of which cannot be much with the
acquisition within 61-day period.
The stock disposed of will be match with an equal number of shares of stock acquired in accordance
with the order of acquisition beginning with the earliest acquisition
If both bands have maturity of six years:
The ordinary gain or capital gains realized from the sale of bonds with more than 5-year
maturity shall not be subject to income tax.