1031 Exchanges and State Tax Withholding on the Sale of Real Property

First and foremost, contrary to popular belief, state tax withholding is not an additional tax. It is simply the withholding of a state’s tax that is ordinarily due upon the sale of real estate at a gain. The withholding is intended to secure payment of taxes on funds that are leaving the state or where a taxpayer has liquidated assets, as it is significantly more difficult for a state taxing authority to subsequently collect taxes from a nonresident taxpayer or a taxpayer without property. Taxes are withheld upon the sale of real property, and if the amount held is more than the amount of tax ultimately due, the excess is refunded to the taxpayer from the state.

Exemptions: It should be noted that there are exemptions to tax withholding in most states (including exemptions for 1031 exchanges). If a taxpayer believes they qualify for an exemption under a state’s withholding statute, they should discuss the same with their tax or legal advisors and plan accordingly.

If you or your client are selling real property located in one of the following states, we highly recommend visiting the state department website (linked below) to learn about each state’s specific tax withholding requirements for residents and nonresidents, as the states below may require some form of withholding or additional filing:

Alabama Maryland* Pennsylvania
California Mississippi Rhode Island*
Colorado New Jersey* South Carolina
Delaware New Mexico Vermont*
Georgia New York West Virginia*
Hawaii* North Carolina
Maine* Oregon

* States with an asterisk have long response times and require exemption applications far in advance of closing.

Please note that the above list is subject to change at each state’s direction and taxpayers should conduct their own due diligence regarding updated withholding requirements.

In the event an Exchanger is subject to a nonresident withholding, it is recommended that the Exchanger or their representative advise Legal 1031 of their status and if required, provide Legal 1031 with a copy of any completed withholding forms.

Please note that Legal 1031 is not authorized to provide legal or accounting advice for purposes of determining amounts to be withheld or completing forms. Exchangers should consult with an experienced tax or legal advisor prior to completing tax forms required by each state.

Legal 1031 Exchange Services LLC 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.

Copyright © 2023 Legal 1031 Exchange Services LLC. All rights reserved. No rights claimed with respect to public domain and fair use materials contained or linked in this article.

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