A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
Historically, Pennsylvania has not recognized the federal 1031 exchange gain deferral rules for individuals and other sellers. This means that state income taxes must be paid when there is a gain on the sale of Pennsylvania property, even if a 1031 exchange is performed at the federal level.
For tax years beginning on or after January 1, 2023, Act 53 of 2022 changed Pennsylvania Personal Income Tax (PIT) law to allow deferral of the gain if the requirements of IRC Section 1031 are met. This aligns Pennsylvania's treatment with federal law for exchanges occurring in these tax years.
In Pennsylvania, real estate tax withholding applies to nonresident sellers.
It's important to consult with a tax advisor to ensure compliance with these rules and to understand any potential exemptions or specific requirements that may apply to your situation.
The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which results in a tax rate increase of 1.18 percent).
Pennsylvania has a flat state income tax of 3.07% of federal taxable income. Additionally, many municipalities in Pennsylvania assess a tax on wages at an average rate of 2.94%.
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
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