Basic Taxation Law: Income Tax Rules on Dealings in Property

Chapter 9

Income Tax Rules on Dealings in Property

A. Capital Gains from Sale or Other Disposition of Real Property

Transaction Covered

• Sale, exchange or other disposition of real property located in the Philippines classified as capital assets, including pacto de retro sales and other forms of conditional sale.

• Individual Taxpayers

• Final tax rate: 6%

• Basis:

• Gross Selling Price or 

• zonal value (current fair market value)

• whichever is higher.

• Taxpayers covered: 

• Citizen

• resident alien, and

• non-resident alien. 

• Option:

• Apply the tax rates under Section 24(A)-20-35% if the buyer is the government or any of its political subdivisions or agencies or government-owned or controlled corporations. 

• Payment: 30 days after the sale. 

• Tax avoidance scheme: FN-18,10-EF

1. The proceeds of the sale must be fully utilized in acquiring or constructing a new principal residence.

• Principal residence shall refer to the dwelling house, including the land on which it is situated, where the husband and wife or an unmarried individual, whether or not qualified as head of family, and members of his family reside. 

• Actual occupancy of such principal residence shall not be considered interrupted or abandon

2. BIR should be notified of the intention to avail of the exemption within 30 days from the date of sale or disposition;

3. Acquisition or construction of new principal residence must be made within 18 months from the date of sale or disposition; 

4. The tax exemption can only be availed of once every 10 years;

5. The buyer/transferee must withhold from the seller and deduct from the selling price the 6% capital gains tax which must be deposited in cash or manager's check with an Authorized Agent Bank (AAB) under an ESCROW Agreement between the Revenue District Officer, the seller, transferee and the AAB.

• ESCROW Agreement 

• refers to a scroll, writing or deed, delivered by the granter, promiser or obliger into the hands of a third person, to be held by the latter until the happening of a contingency or performance of a condition, and then by him delivered to the grantee, promisee or obligee.

6. After depositing the 6% capital gains tax, the buyer/transferee and the seller shall jointly file, within 30 days from the date of the sale or disposition of the principal residence, the Final Capital Gains Tax Return

• Corporate Taxpayers

• Only domestic corporation is subject to: 6% of the 

• gross selling price or

• zonal value (fair market value) 

• whichever is higher.

• Real property: 

• lands and/or buildings which are not actually used in the business.

• Payment: 30 days following the sale or disposition.

• Income realized from the sale of machineries and equipment is subject to normal corporate income. 

• Payment of Capital Gains Tax on Extrajudicial Foreclosure Sale of Capital Assets

• In case the mortgagor exercises his right of redemption within one year from the issuance of the certificate of sale, no capital gains tax shall be imposed because no capital gains has been derived by the mortgagor and no sale or transfer of real property was realized. 

• In case of non-redemption, the capital gains [tax] on the foreclosure sale imposed under Sections 24(0)(1) and 27(0)(5) of the Tax Code of 1997 shall become due based on the bid price of the highest bidder but only upon the expiration of the one-year period of redemption provided for under Section 6 of Act No. 3135, as amended by Act No. 4118, and shall be paid within 30 days from the expiration of the said one-year redemption period. 

B. Gains and Losses from Dealings in Property

Concept

• Include all gains or losses derived from the disposition of property (real, personal or mixed) for money in case of sale, or for property in case of exchange, or from a combination of both sale and exchange. 

• Under the legal definition of gross income, what is included in gross income derived from dealings in property? 

• Answer: It includes all income derived from the disposition of property whether real or personal, or mixed, for money (sale) or for other property (exchange) or for  a combination of both, which results in gain (loss) because of the difference between the taxpayer's investment in what the disposed of and the value In what he received. 

Measure of Income or Loss

Selling Price
Less: Cost
Gain (loss)

• Two conditions: 

1. The property received in exchange is essentially different from the property disposed of; 

2. The property received has a market value. 

Adjusted Basis or Cost of Property Sold

• It depends primarily on the manner in which the taxpayer acquired the property.

By purchase:	acquired before March 1, 1913  FMV on such date; acquired on or after March 1, 1913 Cost + expenses of acquisition
Included in the inventory	its latest inventory value
By devise, bequest or inheritance	FMV or value of such property at the time of the acquisition — death of the decedent.
By gift	the same basis as if it would be in the hands of the donor or the last preceding owner by whom it was acquired by gift, except that  if such basis is greater than the fair market value of the property at the time of the gift, then for the purpose of determining the loss, the basis shall be such fair market value.
Acquired (other than capital assets) for less than an adequate consideration in money or money's worth	amount paid by the transferee
Stock or security property received if the exchange is one where gain or loss may not be recognized	The same as the basis of the stock, or security or property given in exchange.
Stock or security received if the exchange is one where the gain, if any, but not the loss is to be recognized	Basis of the property, stock or security given in exchange  Less: Cash and FMV of property given in exchange  Add: Dividend and/or gain recognized
Property transferred in the hands of the transferee if exchange is one where the gain, if any, but not the loss is to be recognized.	The same basis as it would be in the hands of transferor increased by the amount of the gain recognized to the transferor on the transfer.

Settled Rules on Sale or Exchange

1. Distribution in complete liquidation has been held to be an exchange for the purpose of determining whether or not gain or loss has been realized or sustained within the provisions pertinent. 

2. Conveyance of property in consideration of the transferee's assumption of accrued taxes for which the transferor was personally liable as a compromise of the tax liability on other realty, has been construed to be a sale or exchange within the meaning of the law. 

3. The words "sales or exchanges" have been interpreted quite liberally. Thus, forced sales such as foreclosure sales and tax sale, have been held to be embraced within the meaning of the law. 

4. A sale or exchange will ordinarily be held to occur on the date the transfer of title over the asset is effected or when ownership is terminated in the hands of the transferor. In other words, it is the consummation thereof not the perfection of the contract that is generally taken into account.

5. In condemnation proceedings, the sale occurs at the time of taking of the property rather than when the proceeds of the judgment are received. It is essential that the right of condemnation be legally recognized. 

Tax-Exempt Sales or Exchanges “No Gain, No Loss Recognized”

• Exceptions to the rule that the entire amount of gain or loss shall be recognized:

1. Between corporations that are parties to the merger or consolidation  (Property for Stock)

• A corporation which is a party to a merger or consolidation exchanges property solely for stock in a corporation which is a party to the merger or consolidation.

• The term merger or consolidation shall be understood to mean: 

1. the ordinary merger or consolidation; or 

2. the acquisition by one corporation of all or substantially all the properties of another corporation solely for stock

2. Between two corporations that are parties to the reorganization  (Property for Securities)

• A corporation which is a party to a reorganization exchanges property in pursuance of a plan of reorganization solely for securities in another corporation that is a party to the reorganization.

3. Between two corporations involving exchange of shares of stock (Stock for Stock)

• The acquisition by one corporation, in exchange solely for all or a part of its voting stock, or in exchange solely for all or part of the voting stock of a corporation which is in control of the acquiring corporation, of stock of another corporation if, immediately after acquisition, the acquiring corporation has control of such  other corporation whether or not such acquiring corporation had control immediately before the acquisition.

• The acquisition by one corporation, in exchange solely for all or a part of its voting stock or in exchange solely for all or part of the voting stock of a corporation, of substantially all of the properties of another corporation. 

4. Transfer or exchange of property for stock resulting in acquisition of corporate control (Property for Stock)

• No gain or loss shall be recognized if property is transferred to a corporation by a person in exchange for stock in such corporation of which as a result of such exchange said person, alone or together with other, not exceeding four persons, gains control of said corporation. 

• Stocks issued for services shall not be considered as issued in return of property. 

• However, the BIR ruled that the law would apply even when the exchangor or exchangers already had control of the corporation at the time of the exchange.

• The term control shall mean ownership of stocks in a corporation possessing at least 51 % of the total voting power of all classes of stocks entitled to vote.

• In the foregoing cases, If the taxpayer receives stocks (or securities) and, as a part of the consideration, another party to the exchange assumes a liability of the taxpayer, or acquires from the taxpayer property subject to a liability, then such assumption or acquisition shall not be treated as money/or property, and it shall not prevent the exchange from being exempt.

“Gain Recognized, Loss Not Recognized Rule”

• It applies to the following Transactions: NIRW

1. Transactions not solely in kind (Exchanges of property, stocks or securities plus cash or money);

2. Illegal transactions (2001 Bar);

3. Transaction between related taxpayers:

1. Members of a family;

2. Corporation and individual

• Individual owned more than 50% of the outstanding capital stock of the corporation; 

3. Two corporations 

• more than 50% of the outstanding capital stock is owned by the same individual;

4. Parties to a trust

• trustor,

• trustee, 

• beneficiary and 

• fiduciary.

4. Wash sale transaction (61-day sale).

• Purchase of substantially identical stock or securities beginning 30 days before the date of sale and ending 30 days thereafter.

• Setter must not be a dealer in securities or stock.

• It covers acquisition through a taxable exchange and the making of an option contract.