Dealings In Properties Flashcards
Dealings in Properties
This covers:
- sale or exchange of property, and
- other disposition such as conditional sale or pacto de retro sale
Ordinary Assets
Ordinary assets are:
- 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
- property held by the taxpayer primarily for sale to customers in the ordinary course of trade or business
- property used in trade or business of a character which is subject to allowance for depreciation; and
- real property used in trade or business
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.
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
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
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.
RULES ON TAX BASIS
- Acquisition by purchase - purchase price
- Acquisition by inheritance - fair value as of the date of acquisition
- 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 the transferor
- Acquisition for less than full and adequate consideration - the amount paid by the transferee to the transferor
- Stocks received in exchanged in merger and consolidation, transfer
- Stocks received by the transferee
No gain or loss is recognized when:
- Exchange stock for stock in a merger or consolidation
“Merger and consolidation” means:
- the ordinary merger or consolidation, or
- the acquisition by one corporation of all or substantially all (80%) the properties (assets) of another corporation solely for stock
- 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.
- Stocks issued for services
The stocks issued for services should not be regarded as issued for property
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
- Ordinary gains (long or short term)- fully taxable for both Individuals & Corporations
- Ordinary losses (long or short term)- fully deductible for both Individuals & Corporations
Rules on Dealings in Capital Assets
*Other than corporations:
- Individuals
- GPP
- Estates & trusts
- Tax exempt Joint Ventures (oil exploration & construction)
- Short term capital gains or losses (held for not more than 12 months)
- Other than corporations- 100%
- Corporations- 100%
- Long-term capital gains or losses (held for more than 12 months)
- Other than corporations- 50%
- Corporations- 100%
- Limitation on deduction of capital losses
- Other than corporations- up to the extent of capital gains
- Corporations- up to the extent of capital gains
- Limit of net capital loss carry-over (treated as short term capital loss only in the next period)
- Other than corporations- Not to exceed the net income in the year the capital loss was incurred
- Corporations- Capital loss carry-over is not allowed
Special Considerations in Dealings in Properties
- 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 assets individually.
- Sale of property used for both business and personal purposes - the value of the asset is split into either ordinary or capital assets.
The following are considered sales or exchanges of capital assets.
- 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 evidence of indebtedness issued by a corporation, including the government or its political subdivision, is considered the amount received in exchange therefore.
- 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.
- 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 the holding period for other than the corporate taxpayer.
- Security becomes worthless- This should be distinguished from decline in value. For taxpayers other than bank and trust companies, 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. dinales
- 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.
Outside the scope of dealings in capital assets
- Gains in capital assets covered by capital gains tax
- Gains on sale of real property capital assets - 6% capital gains tax
- Gains on the sale of domestic stock directly to buyer- 5% to10% capital gains tax
- Gains derived from selling ordinary assets
Special Cases in Dealings in Properties
A. CORPORATE RE-ADJUSTMENT
- Merger or Consolidation
- The taxation of corporate readjustments applies only when there are properties or cash transferred under certain circumstances otherwise, gain or loss is not recognized.
- 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
- Due to this, the basis of the shares received shall be determined as follows:
Tax basis of the shares surrendered
Add: Gain recognized
Less: Cash and FMV of property received
= Basis of new shares
- Transfer of property to a controlled corporation
A. Initial transfer together with 4 others resulting in control:
- No cash or property is received (transfer solely for stock)- Gain or loss is not recognized
- 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 under the following circumstances:
- there was a sale of stock or securities at a loss
- 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)
- the acquisition, or option, should be purchased or exchange upon which gain or loss is recognized under the income tax law
- 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 candidates:
- 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 stocks, 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.
