1031 Exchange News:
It’s Baaack – Pennsylvania Reintroduces the Small Business Tax Reform Package for the 2021-22 Legislative Session
By: James T. Walther, Esq., LL.M., General Counsel,
Legal 1031 Exchange Services, LLC
March 30, 2021
**UPDATE: In July 2022, the Pennsylvania Legislature enacted HB 1342, a budget bill that included sweeping tax reform legislation. A provision of the Bill conforms the state’s treatment of like-like exchanges with Section 1031 of the Federal Internal Revenue Code. Previously, state personal income tax did not conform to IRC Section 1031. We believe that the 1031 provision is effective for tax years beginning after December 31, 2022. Taxpayers are encouraged to discuss with advisors the effect of this legislation on transactions.
Updated Article: Pennsylvania Conforms its State Tax Code to Federal §1031
This article has been superseded but left on our page for informational purposes.
Third time is a charm!
This is an update to two previous blogs about the Pennsylvania legislature’s ongoing efforts to recognize IRC Section 1031 Exchanges for its Personal Income Tax (“PIT” 3.07%) which applies to individuals selling real estate and individuals with interests in non-incorporated business entities holding real estate like LLCs, partnerships, trusts, and s-corps taxed as partnerships. For PIT info see PA Bulletin 2006-07 (Revised December 21, 2017).
Just in time for the current Administration and Congress to attempt major tax reform and potentially change Section 1031. For those keeping count, this gets easier each time and makes for solid social media fodder, although there are minor difference is this version of the tax package.
Previous articles:
“Pennsylvania Still Doesn’t Recognize 1031 Exchanges, But Stay Tuned …”, (2018)
On March 10, 2021, the Pennsylvania Senate embarked on its latest effort when it once again reintroduced a Small Business Tax Reform Package, that includes legislation to recognize 1031 exchanges. The legislation was reintroduced and referred to the PA Senate Finance Committee, which must hold hearings on any legislation, that if enacted, is expected to generate a significant reduction tax revenue.
Here is a brief summary of the latest proposed “Small Business Tax Reform Package” PA Senate Bills 347, 348, and 349 (2021):
· Senate Bill 347 “like kind exchanges”: is intended to conform PA state law to federal law by allowing recognition of IRC §1031 tax deferred “like-kind” exchanges and in addition IRC §1035 tax-free insurance policy exchanges. If passed, this Bill would be effective immediately and applies to tax years beginning after December 31, 2020. See my prior article for an explanation of the current status of 1031 Exchanges in PA.
· Senate Bill 348 “Net Operating Loss”: provides for the recognition of net operating loss (“NOL”) carryovers in accordance with IRC Section 195(b) and the corresponding Treasury Regulations. This Bill applies to tax years beginning after December 31, 2020 and if passed is effective immediately. PA currently recognizes federal NOL carryovers, with some limitations – a general limit of 40% of taxable income for tax years after 2019 (35% in 2018 and 30% in prior years). For tax years prior to 2017, a $3 or $5 million flat cap had applied to corporate taxpayers. The cap was held unconstitutional on uniformity grounds by the PA Supreme Court in 2017. (See Nextel Communications of the Mid-Atlantic, Inc. v. P.A. Dept. of Revenue, October 18, 2017). In response, the law was promptly amended to remove the cap and raise the general limits.
· Senate Bill 349 “179 expense deduction”: provides for the recognition of the IRC §179 election to deduct business property as an expense. This change “allows for a tax deduction earlier in the useful life of depreciable assets.” The Bill increases state limits on the expense deduction $100,000 (currently $25,000). The law would also increase the phase out of the deduction to be consistent with the federal limit of $2,000,000. The version of §179 that was in effect at the time the property was placed in service, or the Internal Revenue Code of 1986, whichever is immediately earlier, controls the tax treatment for that specific property. If passed, this Bill/Act would take effect in 60 days after passage.
The proposed legislation is intended to make PA laws friendlier towards small businesses.
“We believe a key to improving our economy is
the success of small businesses that create 65%
of Pennsylvania jobs. Removing unfair tax
obstacles for small businesses allows them to
compete effectively, which helps grow more
jobs for current and future generations.”
See “Senate Co-Sponsorship Memoranda” available at: https://www.legis.state.pa.us/.
If Pennsylvania finally recognizes 1031 exchanges, it would be a major victory for taxpayers and the real estate industry because it could stimulate investment in PA real estate from outside investors, as well as incentivize continued investment by current property owners.
It would also alleviate an accounting burden on Exchangers and their tax professionals with respect to 1031 replacement property because Pennsylvania real estate or even property in another state owned by a Pennsylvania taxpayer can have a different adjusted basis for PA state tax purposes as opposed to its basis for federal tax or its tax basis for another state. This also gets tricky in a partial exchange if a PA taxpayer pays PA tax on all gain due to non-recognition of 1031, but also has to pay tax on “boot” to another state. In addition, in the scenario where a PA taxpayer has to pay tax on substantial gain but is illiquid – they do not have the cash readily available, they often take cash out of the sale proceeds to pay the PA tax. This results in corresponding federal gain that would normally be deferred in an exchange if the proceeds were reinvested in like-kind replacement property. If the Exchanger is a non-resident PA taxpayer, it could also result in additional gain at the state level in their state of residence. Sometimes this can be avoided if the Exchanger can obtain access to non-exchange funds, for example, refinancing a different property or considering a refinance of the replacement property after the dust has settled from the exchange, but these transactions have their own costs, risk, and tax and business considerations. Either way, non-recognition of Section 1031 in PA creates additional considerations for investors and small businesses.
While this legislation is pending, taxpayers should keep in mind that in the past, there have been multiple attempts at similar legislation. Therefore, real estate owners considering the sale of investment or business real estate should carefully analyze their situation and should not delay because of pending legislation. Taxpayers considering a 1031 exchange should always consult with their tax and legal advisors regarding the merits of an exchange and its tax and business planning implications.
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Legal 1031 does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of any transaction. Taxpayers must consult their tax and/or legal advisors for this information. Unless otherwise expressly indicated, any perceived federal tax advice contained in this article/communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
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