Every state in the union – other than Pennsylvania – conformed its tax code to the IRS code to permit residents to take advantage of tax-deferred exchanges under state tax law. Now, finally, Pennsylvania has changed its law to recognize tax-deferred exchanges that comply with federal law.
Previously, Pennsylvania residents deferring gains under federal law had to recognize the gain under state tax law, triggering possible gains tax due at the time of sale. Moreover, residents who used a portion of the gain to pay the state tax, realized “boot” under federal law, requiring taxpayers to pay tax on the money used to pay the state tax! Opponents had long argued that these restrictions impeded commercial real estate sales in Pennsylvania, as owners opted to simply not sell property rather than have to pain the gains taxes.
Now, with the changes which took effect at the beginning of 2023, Pennsylvania taxpayers who successfully defer gains under section 1031 can also defer the gain under state tax code.
It will be interesting to see the effect on the real estate market in Pennsylvania, as experts expect it to be an impetus to sell. If it does have the desired effect, it will be further evidence of the net positive effects that section 1031 has to the overall economy, by encouraging investors to sell investment property and trade into better-performing real estate, creating brokerage and transfer tax revenue at the time of sale, and increasing the overall taxable income to the taxpayer trading ”up” into better performing – and typically more expensive – real estate opportunities.