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 or business), but does not include 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 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, or property used in the trade or business, of a character which is subject to the allowance for depreciation provided in Subsection (F) of Section 34; or real property used in trade or business of the taxpayer.

 Sec. 2 (a) Capital assets shall refer to all real properties held by a taxpayer, whether or not connected with his trade or business, and which are not included among the real properties considered as ordinary assets under Sec. 39(A)(1) of the Code. (REVENUE REGULATIONS NO. 7-2003)
*

 Sec 2 (b) Ordinary assets shall refer to all real properties specifically excluded from the 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 would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year; or

2. Real property held by the taxpayer primarily for sale to customers in the ordinary 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 depreciation provided for under Sec. 34(F) of the Code; or 4. Real property used in trade or business of the taxpayer. *

SEC. 3. GUIDELINES IN DETERMINING WHETHER A PARTICULAR REAL PROPERTY 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 be considered 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 properties which are held by the real estate developer primarily for sale or for lease to customers in the ordinary course of his trade or business or which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year and all real properties used in the trade or business, whether in the form of land, building, or other improvements, shall be considered as ordinary assets. 3. Real Estate Lessor. All real properties of the real estate lessor, whether land and/or improvements, which are for lease/rent or being offered for lease/rent, or otherwise for use 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 in the course of trade or business by a taxpayer habitually engaged in the sale of real estate shall be considered as ordinary assets.

b. Taxpayer not engaged in the real estate business. - In the case of a taxpayer not engaged in the real estate business, real properties, whether land, building, or other improvements, which are used or being used or have been previously used in the trade or business of the taxpayer shall be considered as ordinary assets. c. Taxpayers changing business from real estate business to non-real estate business. In the case of a taxpayer who changed its real estate business to a non-real estate business, or who amended its Articles of Incorporation from a real estate business to a non-real estate business, such as a holding company, manufacturing company, trading company, 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 ordinary asset to capital asset. d. Taxpayers originally registered to be engaged in the real estate business but failed to subsequently operate. In the case of subsequent non-operation by taxpayers originally 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 formerly forming part of the stock in trade of a taxpayer engaged in the real estate business, or formerly being used in the trade or business of a taxpayer engaged or not engaged in the real estate business, which were later on abandoned and became idle, shall continue to be treated as ordinary assets.

f. Treatment of real properties that have been transferred to a buyer/transferee, whether the transfer is through sale, barter or exchange, inheritance, donation or declaration of property dividends. Real properties classified as capital or ordinary asset in the hands of the seller/transferor may change their character in the hands of the buyer/transferee. The classification of such property in the hands of the buyer/transferee shall be determined in accordance with the following rules: 1. Real property transferred through succession or donation to the heir or donee who is not engaged in the real estate business with respect to the real property inherited or donated, and who does not subsequently use such property in trade or business, shall be considered as a capital asset in the hands of the heir or donee.

2. Real property received as dividend by the stockholders who are not engaged in the real estate business and who do not subsequently use such real property in trade or business shall be treated as capital assets in the hands of the recipients even if the corporation which declared the real property dividend is engaged in real estate business. 3. The real property received in an exchange shall be treated as ordinary asset in the hands of the transferee in the case of a tax-free exchange by taxpayer not engaged in real estate business to a taxpayer who is engaged in real estate business, or to a taxpayer who, even if not engaged in real estate business, will use in business the property received in the exchange.

g. Treatment of real property subject of involuntary transfer. In the case of involuntary transfers of real properties, including expropriation or foreclosure sale, the involuntariness of such sale shall have no effect on the classification of such real property in the hands 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 real estate dealer, which are foreclosed, shall, for purposes of determining the applicable tax on such foreclosure sale, be treated as ordinary assets. On the other hand, the nature of such real property in the hands of the foreclosure buyer shall be determined in accordance with the rules stated in sub-paragraph (f) hereof. *

Sec. 22 (Z). The term 'ordinary income' includes any gain from the sale or exchange of property which is not a capital asset or property described in Section 39(A)(1). Any gain from the sale or exchange of property which is treated or considered, under other provisions of this Title, as 'ordinary income' shall be treated as gain from the sale or exchange of property 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 loss from the sale or exchange of property which is treated or considered, under other provisions of this Title, as 'ordinary loss' shall be treated as loss from the sale or exchange of property which is not a capital asset. Calasanz vs. Commissioner of Internal Revenue G.R. No. L-26284 October 8, 1986 xxx a property initially classified as a capital asset may thereafter be treated as an ordinary asset 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 inherited real property usually gives capital gain or loss even though the property has to be subdivided or improved or both to make it salable. However, if the inherited property is substantially improved or very actively sold or both it may be treated as held primarily for sale to customers in the ordinary course of the heir's business. Property initially classified as capital asset may later become an ordinary asset and vice versa.

NOTE: Ordinary income is any gain from sale or exchange of property which is not a capital asset. - Ordinary loss is the opposite. * Net capital gain is the excess of the gains from such sales or exchanges of capital assets 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 taxed 30% after all the deductions have been accounted for. The question is, do you have enough deductions (and proof) which will enable you to get a better deal (i.e. more money after all the taxes are paid out)?

Q: Will the property change nature from ordinary to capital asset? i. Changing from real estate business to a non-real estate business: NO ii. Ceasing operations of the real estate business: NO iii. Real estate business transfers the property to an ordinary person: YES iv. The properties acquired by the real estate business are abandoned: NOv. The properties acquired by the real estate business become idle: NO

 In case of involuntary transfer (like expropriation or foreclosure), the involuntary nature shall have NO effect on the classification in the hands of the involuntary seller. For those NOT engaged in the real estate business, real property being used or have been used in the trade or business are considered ordinary assets.

Q: Can these change into capital assets?

A: YES, provided they show proof that the same have 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 considered for business purposes, and thus are CAPITAL assets.

NET CAPITAL GAINS vs. NET CAPITAL LOSS

* Things to Know About Capital Gains and Losses IRS Tax Tip 2012-35, February 22, 2012 1) Almost everything you own and use for personal purposes, pleasure or investment is a capital asset. 2) When you sell a capital asset, the difference between the amount you sell it for and your basis 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-use property. 5) Capital gains and losses are classified as long-term or short-term. If you hold the property more than one year, your capital gain or loss is long-term. If you hold it one year or 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 normally a net capital gain. Subtract any short-term losses from the net capital gain to calculate the net capital gain you must report.

Rules on Capital Gains and Losses

1) These rules do not apply to: a. Real property with a capital gain tax, and b. Shares of stock of a domestic corporation w/ a capital gain tax, *
- These two kinds of capital assets have their own rates.

2) The transaction on the capital asset should be a sale or exchange.

3) In the case of a taxpayer other than a corporation (for individuals only), the following percentages of the gain or loss shall be taken into account in computing net capital 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 of the gains from such sales or exchanges (limitation on capital loss). If the taxpayer incurs net capital loss, such loss cannot be deducted from his ordinary 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 capital loss, 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 capital asset held for not more than twelve months (100% of the loss). This is what you call the net capital loss carry over. Corporations dont have net capital loss carry-over.

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 while minimizing capital losses. (US Income Tax)

NET CAPITAL GAINS

is the excess of the gains from

NET CAPITAL LOSS

is of the losses from sales or

such sales or exchanges of capital assets over the losses from such sales or exchanges. Is a profit made from the sale of any capital asset where the sale price exceeds the purchase price of the investment. the excess of net long-term capital gain over net shortterm capital loss. (US Income Tax Code)

exchanges of capital assets over the gains from such sales or exchanges. Loss on the sale of an investment asset, such as stocks, bonds, or mutual funds. A loss is incurred if you sell the investment for less than what you paid for it. used for offsetting

Example: *3) In the case of a taxpayer other than a corporation (for individuals only), the following percentages of
the 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 months b. 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 of P20,000, capital gains of P5,000 (from the sale of his personal art collection, which he held for 3 years), and capital losses of P3,000 (from the sale of his yacht, which he held for 2 years).

Ordinary net income Gains from sale of capital asset -But held for 3 years! so 50% Loss from sale of capital asset -But held for 2 years! so 50%
Net taxable gain Taxable Income

P20,000
P5,000 P2,500 P3,000 P1,500 P1,000

P21,000

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

Ordinary net income GAINS from sale of capital asset - 50% only! LOSS from sale of capital asset - 50% only! Net capital LOSS Taxable income

P20,000

P2,000
P1,000 P7,000 P3,500

P2,500
(Cannot deduct)

P20,000

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

GR: Net capital gain shall be reported in the ITR subject to the graduated income 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 traded at the stock exchange (subject to final tax) - Percentage tax on the sale or exchange of shares of stock that are listed and traded at the stock exchange (based on gross selling price) - Percentage tax on the sale or exchange though IPO at the stock exchange 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, jewelry 2) Real property not used in trade or business - Residential house and lot, idle land not used in business operations

 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 gains o Net capital loss carry-over is not applicable. Transactions considered capital transactions even if there is no sale of capital asset, hence resulting into capital gains or losses: o Worthless shares of stock o Worthless bonds o Retirement of bonds with interest coupons or in registered form o Option gains and losses o Liquidating dividends o Liquidation of partnership o Short sales

 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 parties o Wash sales, except those made by dealers in securities o Exchanges NOT solely in kind in mergers and consolidations o 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.

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 as would 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 -

NOT a Sale or Exchange

i.

ii.

Assignment by Joh Corp of a country club share to Mr. John with Mr. John signing a declaration of trust that Joh Corp is the owner of the share (since no transfer of ownership, only beneficial ownership was transfered) 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)