October 2024

GAIN OR LOSS FROM SALE OR EXCHANGE OF PROPERTY

Atty. C. Llamado

Sale or exchange of properties are classified into:

1. Sales resulting to Capital Gains (subject to “CGT”)

a) On the sale of domestic shares.

b) On the sale of real property classified as capital assets.

2. Tax-Free Exchanges – where No Gain nor Loss is Recognized

a) Tax-free exchanges pursuant to a corporate reorganization under Section 40(C)(2) of

the Tax Code (merger or consolidation)
b) Like-Kind Exchanges

3. Sales or Exchanges Where Gain, but Not Loss, is Recognized

a) Exchanges not solely in kind pursuant to a corporate reorganization where boot is

received.
b) Transactions between related persons under Section 36(B) of the Tax Code.
c) Illegal transactions.
d) Wash sale losses of securities

4. (a) Sale or Exchange of Ordinary Assets; and

(b) Sale or Exchange of Other Capital Assets (i.e. capital assets other than
those whose sale is subject to CGT)

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

Sale xxxx
Less: Basis (xxx)
Gain (Loss) xxxx

- 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 xxxx

Less: Basis of property given (xxx)
Gain (Loss) xxxx

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BASIS

a) If property was acquired by purchase, the basis of the property is the cost to the buyer.

b) If property was acquired by inheritance, the basis of the property is the FMV of the
property at the time of death of the decedent (step-up in basis).

c) If the property was acquired by gift, the basis of the property is the basis in the hands of
the donor (carry-over basis). Except that if such basis is greater than the FMV of the
property at the time of the gift, then the basis shall be such FMV for the purpose of
determining the loss.

d) If property was acquired for less than an adequate consideration, the basis of the property
is the amount paid.

e) If property was acquired in a previous tax-free exchange where gain or loss is not
recognized under Section 40(C)(2), the basis is the 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.

Formula:

Basis of property xxxx

Plus: Improvements xxxx
Less: Accumulated Depreciation (xxx)
Adjusted Basis xxxx

Use of Basis
Basis is used to determine:

a) Gain or loss in transactions involving ordinary assets.

b) Gain or loss involving capital assets which are not subject to the CGT.
c) Gain or loss in the sale of domestic shares not traded in the stock exchange.
d) Gain or loss in forced sale of an individual taxpayer of real property to government in
the exercise of the latter’s power of eminent domain; and
e) Gain or loss in the sale of real property classified as capital asset of an RFC or NRFC.

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CLASSIFICATION OF PROPERTIES FOR TAX PURPOSES

Ordinary Assets Capital Assets

a) Stock included in inventory; Asset which is not an ordinary asset, such as:
b) Property primarily held for sale; (1) personal or non-business property or
c) Property used in business which (2) asset held merely for investment, or
is capitalized; (3) property not used in business
d) Real property used in the trade,
business, or profession of the
taxpayer

How taxed? How Taxed?

Gain is 100% included in the ITR. Sale of (a) domestic Sale of capital assets other than
shares held as capital domestic shares held as capital assets,
Loss is 100% deducted in the ITR if assets; (b) real properties or RPCAs.
taxpayer itemizes deductions. in the Philippines
classified as capital
assets (RPCA)
Subject to FTs: Gain/Loss (“G/L”) is recognized,
but only Net Capital Gain is
1) Capital gains tax on included in the ITR:
sale of domestic
shares; 1) If taxpayer is an individual:
2) Capital gains tax on
sale of real property ST1 G/L = 100% recognized
located in the LT2 G/L = 50% recognized
Philippines classified
as capital assets. 2) If taxpayer is a corporation:

100% recognized whether ST or

LT
Other Rules:

3) Capital losses are allowed

only against capital gains

4) Any net capital loss (net capital

loss carry-over) of an individual
taxpayer can be carried over to
the next succeeding year as a ST
NCL, but not to exceed the net
income for the year in which the
capital loss was incurred.

Corporations are not allowed

any net capital loss carry-over.

1
Short-term – holding period of taxpayer is not more than 1 year.
2
Long-term – holding period of taxpayer is more than 1 year.

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Other Transactions Resulting in Capital Gains or 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.3

5) Redemption of preferred shares.

6) Liquidation of partnership. Capital gain or loss is recognized to the partner.

Formula: Amount received for his partnership interest

Less: His investment in the partnership
Less: His share in the undistributed partnership net income
Gain or Loss to Partner (subject to holding period qualification)

7) Gains or losses from short sales.

“Short selling” is 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.

WASH SALE LOSS

Requisites:
1) Sale of securities at a loss; and
2) Identical securities were purchased within a 61-day period, beginning 30 days before
the sale, and ending 30 days after the sale.
3) The taxpayer is either (a) not a dealer in securities, or (b) if a dealer, the sale was not
made in the ordinary course of business.

Notes:
a) “Purchase” includes entering into a contract or option to acquire identical securities.
b) IF taxpayer is a dealer in securities and the sale was made in the ordinary course of
business, the loss on the sale is deductible in the ITR.
c) IF taxpayer is not a dealer in securities or is a dealer but the sale was not made in the
ordinary course of business, the loss on the wash sale is a capital loss, but is not
deductible against capital gains.

Formula for Non-Deductible Loss:

No. of Shares Acquired Within 61 day period x Loss = Non-deductible Loss

No. of Shares Sold

3
Where a corporation distributes all of its assets in complete liquidation or dissolution, the gain realized
or loss sustained by the stockholder, whether individual or corporate, is a taxable income or a deductible
loss, as the case may be (Sec. 73(A), NIRC).

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Formula for Tax Basis of Re-Acquired Shares:

Cost of Acquisition xxxx

+ Non-deductible Wash Sale Loss xxxx
New Tax Basis/Cost xxxx

TAX-FREE EXCHANGES OF PROPERTIES PURSUANT TO A MERGER OR

CONSOLIDATION (CORPORATE REORGANIZATION)4

(1) No gain or loss shall be recognized on a corporation or on its stock or securities if such
corporation is a party to a reorganization, and exchanges property in pursuance to a
plan of reorganization solely for stock or securities5 in another corporation that is a party
to the reorganization.

Notes:

(a) Reorganization refers to (a) merger or consolidation, (b) de facto merger, (c) transfer to
a controlled corporation transaction, (d) recapitalization, or (e) re-incorporation.

(b) No gain or loss shall be recognized by the transferor corporation which is a party to a
reorganization on its transfer of property to another corporation which is also a party to
the reorganization. Provided, the exchange for its property is solely for stock/securities
of such other corporation.

Properties

Corp. A Corp. B
(Transferor) (Transferee)

Only B
shares/securities

The property which may be exchanged by the transferor corporation may consist of any
property, including shares of the transferor corporation. However, the transferee
corporation can only exchange its own shares of stock or securities.

(2) No gain or loss shall also be recognized if property is transferred to a corporation by a

person, alone or together with others, not exceeding four (4) persons, in exchange for
stocks or units of participation in such corporation. As a result of such exchange, the
transferor or transferors, collectively gains or maintains control of said corporation.

4
Sec. 40(C)(2), NIRC.
5
The term securities means bonds and debentures but not notes of whatever class or duration (Sec. 40
(C)(6)(a), NIRC).

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Provided, stocks issued for services shall not be considered as issued in return for
property.6

Notes:

(a) This is another type of transfer to a controlled corporation transaction, but is not
considered a reorganization. This contemplates a situation wherein property is transferred
to a corporation by one or more persons (whether natural or juridical, not exceeding five
(5)) solely in exchange for stock in such corporation, and immediately after the exchange,
such person or persons are in control of the corporation.

(b) The term “control” shall mean ownership of stocks in a corporation, after the transfer of
property, possessing at least fifty-one percent (51%) of the total voting power of all
classes of stocks entitled to vote. The collective, and not the individual ownership of
stocks entitled to vote of the transferor(s) shall be used in determining the presence of
control.7, 8

TAX CONSEQUENCES

(1) The Transferor shall NOT recognize gain or loss (i.e., no CGT, no regular income tax,
no CWT, no donor’s tax, no VAT); and

(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).

Example:

X Corporation (domestic), pursuant to a merger with Y Corporation (domestic), transferred its

Makati real properties used in business (BV = ₱500,000) to Y Corporation. Y corporation, in
turn, transferred 500 of its shares (not traded in the stock exchange) with a FMV at that time
of ₱7,000 per share.

(a) What is the gain of X Corporation? Is the gain taxable?

Fair market value of Y shares received (₱7,000 x 500 shares) ₱ 3,500,000

Less: BV of real properties transferred (500,000)
Ordinary gain ₱ 3,000,000

Answer: The gain is ₱3,000,000. However, because the transaction qualifies under
Section 40(C)(2) of the Tax Code, the gain will not be recognized and will not be included
in the ITR of X Corporation as it is not taxable.

(b) If the real properties exchanged by X Corporation were classified as capital assets, will the
transaction give rise to CGT?

6
Sec. 40(C)(2)(e), NIRC as amended by R.A. No. 11534.
7
Sec. 40(C)(6)(c), NIRC as amended by R.A. No. 11534.
8
It is not required that each of the transferors individually gains control or increases his/its interest. What
is important is that the transferors collectively increase their equity in the transferee corporation to 51%
or more (CIR vs. Northern Tobacco Redrying Co., Inc., CTA EB Case No. 1664, January 31, 2019).

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October 2024

Answer: No. Such Section 40(C)(2) transaction does not give rise to the regular income
tax nor to CGT.

(c) What will the basis of the Y shares?

The basis of the Y shares received will be the same basis in the properties transferred, i.e.
₱500,000. The Y shares will have a basis per share of ₱1,000/share (₱500,000 ÷ 500
shares)

(d) If X Corporation later sells all the 500 Y shares for ₱2.0 Million what will be the tax
consequence to X Corporation?

Selling price of 500 Y shares ₱ 2,000,000

Less: Basis (₱1,000 x 500 Y shares) (500,000)
Gain ₱ 1,500,000

Since the Y shares are not traded in the stock exchange and are capital assets, the ₱1.5
Million gain shall be subject to the 15% CGT.