Recent Taxpayer Victory in Pennsylvania 1031 Case

By: David Shechtman, Esquire, Drinker Biddle & Reath LLP

A recent unreported decision of the Pennsylvania Board of Finance and Revenue (“BFR”) is good news for taxpayers subject to the PA Personal Income Tax (“PIT”) who are engaging, or have engaged, in like-kind exchanges. Affected exchangers now can claim tax-free treatment for PIT purposes in more situations, and those who reported taxable income for PIT purposes in prior years (which are still open) may be eligible for refunds.

As a general matter, for PIT purposes, Pennsylvania does not tax business income (including income from a sale or exchange of property used in the business) based on federal income tax principles.1 Rather, a taxpayer must compute his income using the method of accounting regularly used in keeping his books.2 Acceptable methods include GAAP and other accounting methods which clearly reflect income. A taxpayer may use “federal income tax” as a method of accounting if permissible for his particular trade or business.

Due to the lack of federal conformity, Pennsylvania PIT does not specifically provide for non-recognition of gain or loss on a like-kind exchange of properties meeting the requirements of Internal Revenue Code 1031. In PA PIT Bulletin 2006-07 (Oct. 20, 2006), the Pennsylvania Department of Revenue explained that, despite the lack of a 1031 equivalent for PIT purposes, a taxpayer may defer gain on a like-kind exchange if permitted by the taxpayer’s method of accounting.3 The Bulletin contains an example where a taxpayer consistently uses GAAP and follows APB Opinion 29.4

Although the Bulletin refers to GAAP and APB Opinion 29 solely in an example, the Department has taken the position that non-recognition treatment is available only where the taxpayer’s exchange and accounting treatment conform to the exact circumstances of the “example.” As a result, the Department has denied 1031 treatment for taxpayers who keep their books and records using “federal income tax” as a method of accounting as many real estate partnerships do.

In the recent case, the BFR reversed the Department’s denial of non-recognition treatment on a deferred exchange for a taxpayer whose accounting firm consistently prepared audited financial statements using the federal income tax accounting method. Taxpayer victories are rare at the BFR, all of whose members are state employees. However, the Board held that the Department’s position clearly was at odds with its own Regulations and Bulletin 2006-07. BFR opinions cannot be cited as precedent by other taxpayers. Nevertheless, opinions adverse to the Department of Revenue often result in changes in administrative practice. We understand that the Department will not appeal this decision.

Guest author, David Shechtman, Esquire, is an attorney with Drinker Biddle & Reath LLP, One Logan Square, Suite 2000, Philadelphia, PA 19103. He can be reached at


1 Individuals and individual owners of pass-through entities (e.g., partnerships and S corporations) are subject to Pennsylvania PIT. C Corporations are subject to a separate Corporate Net Income tax, the regime for which generally follows federal income tax principles.
2 See 72 P.S. §7303 (a.1); PA Reg. §101.2
3 The Bulletin further states that the method of accounting must be used on a consistent basis and that a taxpayer may not change his method of accounting just to obtain a tax benefit for a particular transaction.
4 Under GAAP and APB Opinion 29, an exchange qualifies for non-recognition in limited circumstances only, typically where there is a direct swap of equivalent assets between two parties. Deferred like-kind exchanges in which a “qualified intermediary” holds exchange funds for the taxpayer’s benefit generally do not qualify.