Pennsylvania legislature’s ongoing efforts to recognize 1031 exchanges for its personal income tax has prevailed. The Pennsylvania legislature enacted a budget bill, HB 1342, on July 7, 2022 that includes comprehensive tax reform legislation including conforming the state’s tax code to Federal §1031. Effective January 1, 2023, Pennsylvania will recognize 1031 exchanges.
This is great news for real estate investors in Pennsylvania.
By way of background, Section 1031 – Exchange of Real Property Held for Productive Use or Investment is a provision in the U.S. Internal Revenue Code that allows real estate investors to defer paying capital gains tax on the sale of investment property if they reinvest the proceeds into another “like-kind” property which is to be held either for productive use in a trade or business or for investment. Prior to the HB 1342, Pennsylvania taxpayers could defer recognizing the gain for federal income tax purposes, but taxpayers could not defer the gain for Pennsylvania tax purposes.
There are moving parts that real estate investors must understand before attempting a 1031 exchange.
Below are some important points to understand about 1031 exchanges:
- Eligible Properties: Properties that are involved in a 1031 exchange are required to be held for investment, business, or trade purposes. Examples of such eligible properties are rental properties, commercial buildings, vacant land, or even certain types of leases.
- Like-Kind Requirement: The property that is acquired in the exchange (“replacement property”) must be of “like-kind” to the property being relinquished. The term “like-kind” means that both properties must be of a similar nature or character, regardless of differences in quality, location, or other factors. For example, you can exchange a multi-unit apartment building for a strip-mall or vacant land.
- Exchange Process: In order to qualify for a 1031 exchange, strict compliance with the code is required. A plan to replace the investment property with a “like-kind” property must be factored into the initial decision to relinquish the investment property. There are strict deadlines associated with a 1031 exchange. Generally, you have 45 days from the sale of the investment property to identify potential replacement properties, and you must complete the acquisition within 180 days. Therefore, it is very important to have your ducks in a row, so to say.
- Qualified Intermediary: A 1031 exchange requires a qualified intermediary (QI) to facilitate the exchange. The QI is a neutral third party who holds the proceeds from the sale of the relinquished property and uses them to acquire the replacement property on your behalf. An experienced QI will ensure compliance with all IRS regulations.
- Tax Deferral: After successfully completing a 1031 exchange, you can defer paying capital gains tax on the sale of your investment property. This will enable you to reinvest the entire proceeds from the sale into a new property which will increase your purchase power. The tax liability is deferred until you sell the replacement property without executing another 1031 exchange.
It is very important to consult with an expert in the field who specializes in 1031 exchanges. If you have any questions regarding utilizing a 1031 exchange, do not hesitate to contact J Avolio Law and attorney Jonathan Avolio will provide guidance based on the specific details of your transaction.
Disclaimer: The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal advice from the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of any information included in, or accessible through, this Post without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient’s state, country or other appropriate licensing jurisdiction.
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