Big news for Pennsylvania!
House Bill 1342 was signed by Governor Tom Wolf on July 8th and codified the tax deferral benefit of like-kind exchanges beginning in the 2023 tax year. Known as a 1031 or like-kind exchange, Section 1031 of the Internal Revenue Code allows the deferral of gain on the exchange of real properties held for business use or investment. Currently, except for the Commonwealth of Pennsylvania, all states with an income tax regime follow the federal tax code or have adopted their own version of Section 1031. For residents of Pennsylvania or non-residents selling property located in Pennsylvania, you could defer the federal gain, but you cannot defer the Pennsylvania income tax.
This long-awaited change levels the playing field for Pennsylvania taxpayers and non-residents with property in Pennsylvania. Section 1031 requires all proceeds to be reinvested in like-kind replacement property, or tax is due. Under current law, sellers of Pennsylvania property owed income tax on their gain regardless of whether they were effecting a 1031 exchange. To make matters worse, when exchanging, 1031 exchange funds could not be used to pay the Pennsylvania income tax without triggering federal capital gains. The only way to avoid the federal tax is to take the funds out of pocket.
Like-kind exchanges are an invaluable tool that encourages reinvestment, creates jobs, and helps grow the economy. It also paves the way for more commercial development from non-resident investors.
This new law is effective on exchanges initiated beginning January 1, 2023. Unfortunately, the Pennsylvania income tax will be due on all exchanges initiated in 2022.