Lesson 8

Dealings in Properties
Classification of Assets
The definition of ordinary asset is reproduced as follows:
1. Ordinary assets are:
a. stock in trade of the taxpayer, or other property of a kind which would
properly be included in the inventory of the taxpayer if on hand at the end of
the taxable year
b. property held by the taxpayer primarily for sale to customers in the ordinary
course of trade or business
c. property used in trade or business of a character which is subject to
allowance for depreciation; and
d. real property used in trade or business
2. The law provides a definition of ordinary asset as follows with capital asset as
a catchall category, meaning all items of asset that do not fall within the
ordinary category are capital asset.

Basic Terminologies
1. Net Capital Gain – the excess of the gains from sales or exchanges of capital assets
over the losses from such sales or exchanges; included as part of gross income
subject to regular income tax.
2. Net Capital Loss – the excess of the losses from sales or exchanges of capital
assets over the gains from such sales or exchanges. Usually non-deductible but may
be carried over for one year by non-corporate taxpayers.
3. Ordinary Gain or Loss – arise from the sale of ordinary assets sold. Ordinary gain
is fully taxable and ordinary loss is fully deductible. Hence, there is no need to
determine the net ordinary gain or net ordinary loss.

Computation of Gain or Loss

Amount Realized from the sale or disposition* Pxxx,xxx.xx
Basis or adjusted basis** (xxx,xx.xx)
Gain or (Loss) Pxxx,xxx.xx

Realized Amount
Amount Cash received Pxxx,xxx.xx
Fair value of non-cash property received xxx,xxx.xx
Excess of liability assumed over tax basis of property received xxx,xxx.xx
Total realized amount Pxxx,xxx.xx

Rules on Tax Basis**

1. Acquisition by purchase – purchase price
2. Acquisition by inheritance – fair value as of the date of acquisition
3. Acquisition by gift – the basis shall be the basis in the hands of the donor or the
last preceding owner by whom it was not acquired by gift
4. Acquisition for less than full and adequate consideration – the amount paid by the
transferee to the transferor
Basis of stocks given PXX
Less: Money received PXX
Fair value of property received XX XX
Add: Amount treated as dividends PXX
Amount of gain recognized on the exchange XX XX
Basis of stocks received PXX
5. Stocks received in exchanged in merger and consolidation, transferor
6. Stocks received by the transferee
Same basis as in the hand of the transferor Pxxx,xxx.xx
Gain recognized on the transferor xxx,xxx.xx
Basis of property transferred in the hand of the transferee Pxxx,xxx.xx

Rules on Exchange of Property

A. No gain or loss is recognized for the following:
1. Exchange stock for stock in a merger or consolidation
“Merger and consolidation” means:
a. the ordinary merger or consolidation, or
b. the acquisition by one corporation of all or substantially all (80%) the
properties (assets) of another corporation solely for stock
2. Initial acquisition of control by exchanging property unilaterally or with 4
others
“Control” shall mean ownership of stocks in a corporation possessing at least
fifty-one percent (51%) of the total voting power of all classes of stocks
entitled to vote.
3. Stocks issued for services.
The stocks issued for services should not be regarded as issued for property.

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Lesson 8
Dealings in Properties
B. Only Gain, except loss, is recognized when the exchange is not solely in kind
When cash or property is received in addition to stocks, only gain but not loss is
recognized in a merger or consolidation. However, the gain to recognize shall not
exceed the total of cash or fair market value of such other properties received.
Exception: when the cash or properties received has the effect of distribution of
dividends, the amount of cash or properties representing the proportionate share of
the taxpayer in the undistributed earnings and profits of the corporation shall be
treated as dividends. The excess shall be treated as capital gain.

Rules on Dealings in Ordinary Assets

Other than corporations Corporations
Ordinary gains(long or short term) Fully taxable Fully taxable
Ordinary losses (long or short term) Fully deductible Fully deductible

Rules on Dealings in Capital Assets

Other than corporations Corporations
Short term capital gains or losses held for
not more than 12 months (Short-term capital 100% 100%
gain/loss)
Long-term capital gains or losses held for
more than 12 months (Long-term capital 50% 100%
gain/loss)
Up to the extent of Up to the extent
Limitation on deduction of capital losses
capital gains of capital gains
Not to exceed the net
Limit of net capital loss carry-over Capital loss
income in the year the
(treated as short term capital loss only in carry-over is
capital loss was
the next period) not allowed
incurred

Examples of taxpayers other than corporations

a. Individuals
b. General professional partnership
c. Estates and trusts
d. Tax-exempt joint ventures

Special Considerations
a. Sale of an entire business – the sale is treated as sale of the different assets of
the business; the rules of gains on dealings are applied to the relevant items of
asset individually.
b. Sale of property used for both business and personal purposes - the value of the
asset is split into either ordinary or capital asset.

Transactions considered exchanges

The following are considered sales or exchanges of capital asset:
1. Retirement of bonds, debentures, notes, or certificates and other evidence of
indebtedness - the amounts received by the holder upon the retirement of bonds,
debentures, notes, or certificates and other evidences of indebtedness issued by a
corporation, including the government or its political subdivision, is considered
amount received in exchange therefore.
2. Short sale of properties – selling of securities by a speculator who does not own
them in anticipation of a decline in value of the securities so as he could derive
gains upon replacing them at a lower cost. The short sale is not consummated until
the property borrowed is replaced. Note that short selling is now prohibited in the
Philippines.
3. Failure to exercise a privilege or option to buy or sell property that is capital
asset. For this purpose, the expiry date of the option from the time it is written
shall be the reckoning period in determining holding period for other than corporate
taxpayer.
4. Security becoming worthless. This should be distinguished from decline in value. For
taxpayers other than bank and trust company, the loss therefrom shall be considered
to happen on the last day of the year of write-off.
Note: for banks and trust companies incorporated under the Philippine laws a
substantial part of whose business is the receipt of deposit, this item is an
ordinary loss since it is connected with its business.
5. Receipt of a liquidating dividends - excess liquidating dividends from the cost of
the investment is regarded as a capital gain. Similar rules apply with the amount
received in liquidation of a partnership.

What are outside the scope of dealings in capital assets?

1. Gains in capital assets covered by capital gains tax
a. Gains on sale of real property capital assets – 6% capital gains tax
b. Gains on the sale of domestic stock directly to buyer – 5%-10% capital gains
tax
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Lesson 8
Dealings in Properties
2. Gains derived from selling ordinary assets

Special Cases in Dealings in Properties

A. CORPORATE RE-ADJUSTMENT
1. Merger or Consolidation
o The taxation of corporate readjustments applies only when there are properties
or cash transferred under certain circumstances; otherwise, gain or loss is
not recognized
o If there is cash or property received aside from the shares in the exchange,
recognize gain to the extent of the sum of money and fair market value of
property received but loss is not recognized
o Due to this, the basis of the shares received shall be determined as follows:
Tax basis of the shares surrendered Pxxx,xxx.xx
Add: Gain recognized xxx,xxx.xx
Less: Cash and FMV of property received xxx,xxx.xx
Basis of new shares received Pxxx,xxx.xx
2. Transfer of property to a controlled corporation
a. Initial transfer together with 4 others resulting to control
i. No cash or property is received (transfer solely for stock)
 Gain or loss is not recognized
ii. Cash or property is received
 the same rules as in merger with cash or property received
apply (i.e.: gain is recognized but loss is not recognized; the
determination of the basis of the new shares received also
apply)
b. Transfer to a corporation with pre-existing control
This is no longer a corporate readjustment and normal tax rules apply
hence, gain or loss is recognized; Note that the accounting economic entity
concept does not apply in taxation; a separate entity by legal form is a
separate entity under taxation
B. WASH SALES
Wash sale is a sale is sale under the following circumstances:
a. there was a sale of stock or securities at a loss
b. within a period beginning thirty days before, and ending thirty days after, the
date of sale or disposition (61-day rule), there was an acquisition of shares or
securities (or option to acquire the shares or securities)
c. the acquisition, or option, should be purchased or exchange upon which gain or
loss is recognized under the income tax law
d. the stock or securities acquired were substantially the same as those disposed of
Wash sales loss is non-deductible. The non-deductible loss is treated as part of the
cost basis of the securities acquired.

Note to students:
 Wash sales rules apply only on sale, exchange or other disposition of securities
(stocks or debt) classified as capital assets. The rules do not apply to dealers in
securities because securities form part of their ordinary assets. Short term trading is
a normal part of business. It is believed that limiting claimable losses on short term
trading would be oppressive to the taxpayer involved.
 When the security involved is a domestic stock, wash sales rules apply to the
computation of the deductible losses for purposes of the determination of the relevant
capital gains tax on the sale, exchange or other disposal of domestic stocks directly
to buyer.