1031 Exchange in Pennsylvania: Act 53, Transfer Tax and DST Options

Pennsylvania only started honoring exchanges in 2023

Pennsylvania recognizes 1031 deferral for personal income tax only for transactions occurring in tax years beginning after December 31, 2022. Act 53 of 2022 rewrote section 303(a.5) of the Tax Reform Code so that the requirements of sections 1031 and 1035 of the Internal Revenue Code 'shall be applicable,' and the Department of Revenue's Personal Income Tax Guide now states that effective January 1, 2023 the deferral of tax on gains from like-kind exchanges is allowed.

The state test is now the federal test. If your exchange qualifies under IRC section 1031, using an independent intermediary and the identification and closing windows covered in our deadlines guide, Pennsylvania defers the same gain; there is no separate Pennsylvania election, form or fee, and the deferred amount simply stays off PA-40 Schedule D for that year.

Act 53 changed the personal income tax article of the Tax Reform Code and nothing else. Realty transfer tax was not amended, so each deed in the exchange still carries the state and local transfer tax described below.

Exchanges completed before 2023 left a separate Pennsylvania tax history

For tax years before 2023 the Department treated a like-kind exchange as a taxable disposition and collected 3.07% on the gain in the year of the exchange, a position it held for years before the General Assembly changed the statute.

That history matters if you still own property acquired through a pre-2023 exchange. Federally your basis carried over from the relinquished property, but Pennsylvania already taxed that gain, so the property's Pennsylvania tax history is not the same as its federal one; have a CPA reconcile the two before you sell or exchange again, and keep the PA-40 Schedule D from the exchange year.

Act 53 contains no refund mechanism for earlier exchanges. On its face the amendment applies to transactions in tax years beginning after December 31, 2022, so a relinquished property sold in 2022 by a calendar-year taxpayer was a 2022 transaction under the old rule even if the replacement closed in 2023; ask your CPA how the Department treated any exchange that straddled the change.

A flat 3.07% on gains, with no loss netting across income classes

Pennsylvania taxes the gain on investment real estate at the same flat 3.07% it applies to wages. There is no preferential capital-gains rate and no exclusion for long holding periods; the gain falls into the class 'net gains from the sale, exchange or disposition of property,' one of the eight classes of income on the PA-40.

The eight-class system has a sting that makes deferral worth more than the rate suggests: Pennsylvania does not allow a loss in one class to offset gain in another, or a loss of one spouse to offset the other's gain. A loss from rents and royalties cannot shelter the gain on a sale.

On a $1,000,000 gain the Pennsylvania tax alone is $30,700. Philadelphia residents should also check the city's School Income Tax, 3.74% for 2025, which reaches residents' unearned income including short-term capital gains; whether it touches a particular sale depends on the holding period and the city's regulations.

Pennsylvania withholds from nonresident landlords, not from nonresident sellers

Pennsylvania has no withholding at closing when a nonresident sells real estate. The settlement agent releases the full net proceeds to the intermediary, and the nonresident seller reports the sale, or the deferral, on a nonresident PA-40 the following spring.

The withholding Pennsylvania does impose targets rent. A lessee paying lease payments for Pennsylvania real estate in the course of a trade or business to a nonresident lessor must withhold 3.07%, optional below $5,000 a year per payee and required above it, reported on Form 1099-MISC with the REV-1667 annual reconciliation through myPATH. 'Lease payments' include rents, royalties, bonus payments and damage rents.

An out-of-state owner of a Pennsylvania commercial or industrial rental therefore sees that withholding on the way in and nothing on the way out; once the property is sold there are no further Pennsylvania withholdings for a nonresident seller.

Realty transfer tax is paid on both legs: 1% state plus local, 4.578% in Philadelphia

Every deed in a Pennsylvania exchange carries realty transfer tax: 1% to the Commonwealth on the value of the real estate, plus a local tax that municipalities and school districts may share. Grantor and grantee are jointly and severally liable for the state tax, and custom rather than law splits the bill evenly.

Philadelphia is the outlier. The city's own rate is 3.578%, which with the Commonwealth's 1% makes 4.578% of the sale price; the city notes the tax is usually split between buyer and seller but that it can collect all of it from either party.

A 1031 exchange does not reduce or defer transfer tax, and it is paid again if you acquire Pennsylvania replacement property by deed. Whether transfer tax paid from exchange proceeds is treated as an exchange expense is a federal question for your qualified intermediary and CPA.

County base-year assessments: a Pennsylvania sale does not reassess the property

Selling a Pennsylvania property does not trigger a reassessment. Under the Consolidated County Assessment Law counties value property as of a base year, and section 8817 lets assessors change an individual assessment only when land is subdivided or improvements are added, removed or destroyed; a sale is not on the list, and the law separately prohibits spot reassessment.

The flip side is that Pennsylvania has no statewide reassessment cycle. Each county decides when to conduct a countywide revision, so base years differ from county to county, and a buyer's tax bill follows the county's base-year value rather than the price paid.

For an investor exchanging out of Pennsylvania, the assessment you have been paying on is what the buyer inherits; for an investor exchanging into Pennsylvania property, the bill you underwrite is the seller's, not one recalculated from your purchase.

Philadelphia landlords also owe the Net Profits Tax on rental income, and a non-resident who exchanges out of the city stops paying it

Philadelphia taxes the net profits of a trade, business, profession or enterprise carried on by city residents, wherever the business sits, and by non-residents on business conducted inside the city. The Department of Revenue's Net Profits Tax page says that 'the rental of property, in most cases, is considered the operation of a business,' so a Philadelphia rental held by an individual, a partnership, an LLC or a trust files a Net Profits Tax return every April 15, even in a loss year, and makes two estimated payments on April 15 and June 15 of 25 percent of the prior year's tax each.

For tax year 2025, with returns due April 15, 2026, the rate is 3.74 percent for residents and 3.43 percent for non-residents, down from 3.75 and 3.44 percent the year before. The city had not posted a tax year 2026 rate when this page was checked. A 60 percent credit for the net-income portion of the Business Income and Receipts Tax offsets part of the bill. On a hypothetical $100,000 of net rental profit, the tax is $3,740 for a resident and $3,430 for a non-resident before that credit; have your CPA run the figures for your return.

The exchange changes the picture by geography, not by deferral. A 1031 exchange defers the 3.07 percent state tax and the federal tax on the gain, but the Net Profits Tax is an annual levy on operating profit, and the city's page does not say how the gain on the sale itself is treated, so ask before closing. What the exchange does settle is next year's return: a non-resident who replaces a Philadelphia building with property outside the city, or with a DST holding property in another state, conducts no business in Philadelphia and files no Net Profits Tax return for it.

A city resident does not get the same result. The tax follows a resident's business income regardless of where the rental sits, so a Philadelphia resident who buys a replacement rental in Bucks County or Florida keeps filing. Whether DST distributions to a resident are net profits of a business the resident operates, or unearned income that the School Income Tax reaches instead, is not addressed on the city's pages; a Philadelphia CPA should classify that income before the first distribution.