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CAPITAL GAINS AND LOSSES(SALE OR EXCHANGE PROPERTY)

SEC. 39. Capital Gains and Losses. -

(A) Definitions. - As used in this Title -

(1) Capital Assets - The term "capital assets" means property held

by the taxpayer (whether or not connected with his trade orbusiness), but does not include stock in trade of the taxpayer orother property of a kind which would properly be included in theinventory of the taxpayer if on hand at the close of the taxable

year, or property held by the taxpayer primarily for sale to

customers in the ordinary course of his trade or business, orproperty used in the trade or business, of a character which issubject to the allowance for depreciation provided in Subsection(F) of Section 34; or real property used in trade or business of thetaxpayer.

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Sec. 2 (a) Capital assets shall refer to all real

properties held by a taxpayer, whether or not

connected with his trade or business, andwhich are not included among the real

properties considered as ordinary assets under

Sec. 39(A)(1) of the Code. (REVENUE

REGULATIONS NO. 7-2003)

*

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Sec 2 (b) Ordinary assets shall refer to all real properties specifically excluded

fromthe definition of capital assets under Sec. 39(A)(1) of the Code, namely:

1. Stock in trade of a taxpayer or other real property of a kind which wouldproperly be included in the inventory of the taxpayer if on hand at the close of thetaxable year; or

2. Real property held by the taxpayer primarily for sale to customers in theordinary course of his trade or business; or

3. Real property used in trade or business (i.e., buildings and/or

improvements) of a character which is subject to the allowance for depreciationprovided for under Sec. 34(F) of the Code; or

4. Real property used in trade or business of the taxpayer.

*

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SEC. 3. GUIDELINES IN DETERMINING WHETHER A PARTICULAR REALPROPERTY IS A CAPITAL ASSET OR ORDINARY ASSET. (RR 7-2003)

a. Taxpayers engaged in the real estate business. Real property shall be classified with

respect to taxpayers engaged in the real estate business as follows:

1. Real Estate Dealer. - All real properties acquired by the real estate dealer shall beconsidered as ordinary assets.

2. Real Estate Developer. All real properties acquired by the real estate developer,whether developed or undeveloped as of the time of acquisition, and all real propertieswhich are held by the real estate developer primarily for sale or for lease to customers inthe ordinary course of his trade or business or which would properly be included in theinventory of the taxpayer if on hand at the close of the taxable year and all real propertiesused in the trade or business, whether in the form of land, building, or otherimprovements, shall be considered as ordinary assets.

3. Real Estate Lessor. All real properties of the real estate lessor, whether land and/orimprovements, which are for lease/rent or being offered for lease/rent, or otherwise foruse or being used in the trade or business shall likewise be considered as ordinary assets.

4. Taxpayers habitually engaged in the real estate business. - All real properties acquired inthe course of trade or business by a taxpayer habitually engaged in the sale of real estate

shall be considered as ordinary assets.

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b. Taxpayer not engaged in the real estate business. - In the case of a taxpayer notengaged in the real estate business, real properties, whether land, building, or otherimprovements, which are used or being used or have been previously used in the trade orbusiness of the taxpayer shall be considered as ordinary assets.

c. Taxpayers changing business from real estate business to non-real estatebusiness. In the case of a taxpayer who changed its real estate business to a non-realestate business, or who amended its Articles of Incorporation from a real estate business toa non-real estate business, such as a holding company, manufacturing company, tradingcompany, etc., the change of business or amendment of the primary purpose of the

business shall not result in the re-classification of real property held by it from ordinaryasset to capital asset.

d. Taxpayers originally registered to be engaged in the real estate business butfailed to subsequently operate. In the case of subsequent non-operation by taxpayersoriginally registered to be engaged in the real estate business, all real properties originally

acquired by it shall continue to be treated as ordinary assets.

e. Treatment of abandoned and idle real properties. - Real properties formerlyforming part of the stock in trade of a taxpayer engaged in the real estate business, orformerly being used in the trade or business of a taxpayer engaged or not engaged in thereal estate business, which were later on abandoned and became idle, shall continue to betreated as ordinary assets.

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f. Treatment of real properties that havebeen transferred to a buyer/transferee,

whether the transfer is through sale, barteror exchange, inheritance, donation ordeclaration of property dividends.

Real properties classified as capital or ordinaryasset in the hands of the seller/transferor maychange their character in the hands of the

buyer/transferee. The classification of suchproperty in the hands of thebuyer/transferee shall be determined inaccordance with the following rules:

1. Real property transferred through succession

or donation to the heir or donee who is notengaged in the real estate business with respectto the real property inherited or donated, andwho does not subsequently use such propertyin trade or business, shall beconsidered as a capital asset in the hands of theheir or donee.

2. Real property received as dividend bythe stockholders who are not engaged

in the real estate business and who donot subsequently use such real propertyin trade or business shall be treated ascapital assets in the hands of therecipients even if the corporation whichdeclared the real property dividend is

engaged in real estate business.

3. The real property received in anexchange shall be treated as ordinaryasset in the hands of the transferee inthe case of a tax-free exchange bytaxpayer not engaged in real estatebusiness to a taxpayer who is engaged inreal estate business, or to a taxpayerwho, even if not engaged in real estatebusiness, will use in business the

property received in the exchange.

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g. Treatment of real property subject of involuntary transfer. -In the case of involuntary transfers of real properties, includingexpropriation or foreclosure sale, the involuntariness of such saleshall have no effect on the classification of such real property in thehands of the involuntary seller, either as capital asset or ordinary

asset, as the case may be.

For example, real properties forming part of the inventory of a realestate dealer, which are foreclosed, shall, for purposes of determiningthe applicable tax on such foreclosure sale, be treated as ordinary

assets. On the other hand, the nature of such real property in thehands of the foreclosure buyer shall be determined in accordance

with the rules stated in sub-paragraph (f) hereof.

*

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Sec. 22 (Z). The term 'ordinary income' includes any gain from the sale or exchange ofproperty which is not a capital asset or property described in Section 39(A)(1). Any gainfrom the sale or exchange of property which is treated or considered, under other provisionsof this Title, as 'ordinary income' shall be treated as gain from the sale or exchange ofproperty which is not a capital asset as defined in Section 39(A)(1). The term 'ordinary loss'includes any loss from the sale or exchange of property which is not a capital asset. Any lossfrom the sale or exchange of property which is treated or considered, under other provisionsof this Title, as 'ordinary loss' shall be treated as loss from the sale or exchange of propertywhich is not a capital asset.

Calasanz vs. Commissioner of Internal RevenueG.R. No. L-26284 October 8, 1986

xxx a property initially classified as a capital asset may thereafter be treated as an ordinaryasset if a combination of the factors indubitably tend to show that the activity was in

furtherance of or in the course of the taxpayer's trade or business. Thus, a sale of inheritedreal property usually gives capital gain or loss even though the property has to be subdividedor improved or both to make it salable. However, if the inherited property is substantiallyimproved or very actively sold or both it may be treated as held primarily for sale tocustomers in the ordinary course of the heir's business.

Property initially classified as capital asset may later become an ordinary asset and vice

versa.

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NOTE: Ordinary income is any gain from sale or exchange of property which is nota capital asset.

- Ordinary loss is the opposite.* Net capital gain is the excess of the gains from such sales or exchanges of capitalassets over the losses from such sales or exchanges.

- Net capital loss is the opposite.

Q: Is it better for real property to be considered capital or ordinary asset?- Depends.

Example: ABC Corporation sells a piece of land for P100k.Q: Do you want to consider it as capital or ordinary?

- If it were capital, youd get taxed 6% of P100k (capital gains tax), thats

P6,000. You go home with P94k.

- If it were ordinary, itll be part of your gross income, which will be taxed30% after all the deductions have been accounted for. The question is, do you haveenough deductions (and proof) which will enable you to get a better deal (i.e. moremoney after all the taxes are paid out)?

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Q: Will the property change nature from ordinary tocapital asset?

i. Changing from real estate business to a non-real estatebusiness: NO

ii. Ceasing operations of the real estate business: NOiii. Real estate business transfers the property to an ordinary

person:YESiv. The properties acquired by the real estate business are

abandoned: NOv. The properties acquired by the real estatebusiness become idle: NO

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In case of involuntary transfer (like expropriationor foreclosure), the involuntary nature shall haveNO effect on the classification in the hands of theinvoluntary seller.

For those NOT engaged in the real estate business,real property being used or have been used in thetrade or business are considered ordinary assets.

Q: Can these change into capital assets?

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A: YES, provided they show proof that the samehave not been used in business for more than 2

years (prior to the taxable transaction).

For EXEMPT corporations, real property used

in exempt transactions shall not be consideredfor business purposes, and thus are CAPITALassets.

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NET CAPITAL GAINSvs.

NET CAPITAL LOSS

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*Things to Know About Capital Gains and LossesIRS Tax Tip 2012-35, February 22, 2012

1) Almost everything you own and use for personal purposes, pleasure or investment is acapital asset.

2) When you sell a capital asset, the difference between the amount you sell it for and yourbasis which is usually what you paid for it is a capital gain or a capital loss.

3) You must report all capital gains.

4) You may only deduct capital losses on investment property, not on personal-useproperty.

5) Capital gains and losses are classified as long-term or short-term. If you hold theproperty more than one year, your capital gain or loss is long-term. If you hold it one yearor less, the gain or loss is short-term.

6) If you have long-term gains in excess of your long-term losses, the difference is normallya net capital gain. Subtract any short-term losses from the net capital gain to calculate thenet capital gain you must report.

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3) In the case of a taxpayer other than a corporation (for individuals only), thefollowing percentages of the gain or loss shall be taken into account in computing netcapital gain, net capital loss and net income: (Percentages taken into account by

Taxpayers other than Corp.)a. 100% of the gain/loss, if the asset has been held for not more than 12 months

(short term)b. 50% of the gain/loss, if the asset has been held for more than 12 months.

(long term)Note that for corporations, capital gains and losses are always considered at 100%.

4) Losses from sales or exchanges of capital assets shall be allowed only to the extent ofthe gains from such sales or exchanges (limitation on capital loss).

If the taxpayer incurs net capital loss, such loss cannot be deducted from hisordinary income because the loss can be deducted only to the extent of capital gains.

5) If any taxpayer, other than a corporation, sustains in any taxable year a net capitalloss, such loss, in an amount not in excess of the net income (taxable income) of such

year, shall be treated in the succeeding year as a loss from a sale or exchange of a capitalasset held for not more than twelve months (100% of the loss). This is what you call thenet capital loss carry over.

Corporations dont have net capital loss carry-over.

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Gains and losses from the sale or exchange of capital assets receive separate treatment from

"ordinary" gains and losses. Capital gains are taxed before income, at a significantly lower rate than

ordinary gains. Capital losses, on the other hand, are only useful to offset capital gains and a small

amount of personal income. As a result, tax planners often attempt to maximize capital gains whileminimizing capital losses. (US Income Tax)

NET CAPITAL GAINS NET CAPITAL LOSS

is the excess of the gains from

such sales or exchanges ofcapital assets over the lossesfrom such sales or exchanges.

Is a profit made from the sale ofany capital asset where the saleprice exceeds the purchase price

of the investment. the excess of net long-term

capital gain over net short-term capital loss. (US IncomeTax Code)

is of the losses from sales or

exchanges of capital assets overthe gains from such sales orexchanges.

Loss on the sale of aninvestment asset, such as stocks,bonds, or mutual funds.

A loss is incurred if you sell theinvestment for less than what

you paid for it.

used for offsetting

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Example: *3) In the case of a taxpayer other than a corporation (for individuals only), the following percentages ofthe gain or loss shall be taken into account in computing net capital gain, net capital loss and net income:

a. 100% of the gain/loss, if the asset has been held for not more than 12 monthsb. 50% of the gain/loss, if the asset has been held for more than 12 months.

Note that for corporations, capital gains and losses are always considered at 100%.

1) Mao is in the buy and sell business, and he had ordinary income ofP20,000, capital gains ofP5,000 (from the sale of his personal artcollection, which he held for3 years), and capital losses ofP3,000 (fromthe sale of his yacht, which he held for 2 years).

Ordinary net income P20,000Gains from sale of capital asset P5,000

-But held for 3 years! so 50% P2,500Loss from sale of capital asset P3,000

-But held for 2 years! so 50% P1,500

Net taxable gain P1,000

Taxable Income P21,000

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2) Same facts, but Mao had capital gains of P2,000, and capital losses of P7,000.

Ordinary net income P20,000GAINS from sale of capital asset P2,000

- 50% only! P1,000LOSS from sale of capital asset P7,000

- 50% only! P3,500

Net capital LOSS P2,500(Cannot deduct)

Taxable income P20,000

NOTE: You cant deduct the capital loss of P2,500 because you can only deduct tothe extent of your capital gains.

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GR: Net capital gain shall be reported in the ITR subject to the graduatedincome tax rates in addition to the net income from other sources

EXCEPT:- Capital gains from the sale of real property (subject to final tax)- Capital gains from sale of shares of stock that are not listed and

tradedat the stock exchange (subject to final tax)

- Percentage tax on the sale or exchange of shares of stock that arelisted and traded at the stock exchange (based on gross selling price)- Percentage tax on the sale or exchange though IPO at the stockexchange

Note: These exceptions have their own special tax returns.

Examples of properties classified as capital assets:1) Personal property not used in trade or business

- Movables in ones residence, vehicles, appliances, furniture, jewelry2) Real property not used in trade or business

- Residential house and lot, idle land not used in business operations

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Limitations on the capital asset transactions of corporations:

o Holding period rules not applicable, always 100%o Capital losses are allowed only to the extent of capital gainso Net capital loss carry-over is not applicable.

Transactions considered capital transactions even if there is no saleof capital asset, hence resulting into capital gains or losses:

o Worthless shares of stocko Worthless bonds

o Retirement of bonds with interest coupons or in registered formo Option gains and losseso Liquidating dividendso Liquidation of partnershipo Short sales

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Computation of gain or loss of a partner when partnership is dissolved: *- Return on investment upon liquidation

Less: investment on partnership Less: share in undistributed net income

- Equals: Gain (loss) on partnership liquidation

Following sales or exchanges result into taxable gain but NO LOSS

recognition:o Sales or exchanges between related partieso Wash sales, except those made by dealers in securitieso Exchanges NOT solely in kind in mergers and consolidationso Illegal transactions

o Sales or exchanges in general which are NOT at arms length

Note: Businessman sold the building where he opened his supermarket.- Ordinary assetobtain the gains/loss.

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Sale or Exchange There is a sale or exchange of property when there is an effective

and actual transfer of ownership of the property to another aswould divest the transferors of the benefits accruing from the

ownership of the property, for a valuable consideration.

What is important is when the sale or exchange is consummated,not perfected.

Thus, it includes:

i. Forced sales/Sheriffs Sale

ii. Distribution in complete liquidation -

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NOT a Sale or Exchangei. Assignment by Joh Corp of a country club share to Mr.

John with Mr. John signing a declaration of trust that JohCorp is the owner of the share (since no transfer of

ownership, only beneficial ownership was transfered)ii. Conveyance of the common areas of a condominium

from the developer to the condominium corporation(since no consideration and conveyance is merely for the

management of the common areas)