Exchanging Thoughts

State Taxes and 1031 Exchange

Posted by Margo McDonnell on Fri, Oct 19, 2012

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This Free for All Friday post is devoted to clarifying state income tax issues and state withholding requirements when it comes to a 1031 tax-deferred exchange.

Deferral of State Gain

Most states will recognize a 1031 exchange and allow you to defer the state gain as well as the federal gain. However, there are a few states (including the Commonwealth of Pennsylvania) that will not recognize an exchange at all and some that have special requirements (such as acquiring replacement property within the same state). Other states have no income tax.

Pennsylvania has a few quirks:

    • Pennsylvania imposes state income taxes on all resident taxpayers as well as any non-resident taxpayer that makes money in the Commonwealth. 
    • Pennsylvania residents that sell property in Pennsylvania or anywhere else are required to pay Pennsylvania income tax. 
    • Non-resident taxpayers selling property in Pennsylvania are required to pay Pennsylvania income tax on the profits even if the taxpayer can complete in a 1031 exchange in their home state or if there is no income tax in their home state.

Non-Resident Withholding Tax

Many states have enacted mandatory non-resident withholding taxes that must be withheld at the time of sale if the seller is not a resident of that state.  

Closing agents in these states must submit a check representing the required withholding tax to the Recorder of Deeds in order to have the Deed recorded.  

When completing a 1031 exchange, the Exchanger may file for an exemption but most states require this be completed prior to closing.  

The following States currently have non-resident withholding requirements: 

  • New Jersey;
    • NJ does not require paperwork be completed prior to closing.
  • California, Colorado, Delaware, Georgia, Hawaii, Maine, Maryland, Mississippi, New York, North Carolina, Rhode Island, South Carolina, Vermont and West Virginia. 
    • These states require paperwork be filed with the state prior to closing. 

Keep in mind other States may enact laws requiring a non-resident withholding tax. 

Your 1031 CORP. Exchange Officer always instructs closing officers to let us know if their state has a mandatory non-resident withholding so we can call it to your attention as soon as possible.


Topics: tax consequences of a 1031 exchange, state withholding taxes and 1031; state income tax