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Philadelphia’s Tax Treatment of IRC §1031 Exchanges for
Business Income and Receipts Tax (BIRT) and Net Profits Tax
(NPT)
Overview of IRC § 1031
No gain recognition
No gain or loss is recognized under IRC §1031 on the exchange of real property held
for productive use in a trade, business or for investment if that property is
exchanged solely for property of a like-kind which is to be held either for productive
use in a trade, business or for investment. This non-recognition treatment, however,
does not apply to stock in trade or to property primarily held for sale.
Like – kind property
The term “like-kind” relates to the nature and character of the properties
exchanged, rather than to their grade or quality. Although properties don’t have to
be identical, a comparison of properties occurs. The comparison determines
whether a taxpayer has acquired a new asset or merely exchanged an asset of
similar nature or character. Real estate, whether improved or unimproved, as well
as depreciable tangible personal property used in a trade or business, can be
exchanged under §1031. The exchange of property does not have to be
simultaneous but, time limits exist for the identification and receipt of replacement
property.
Receipt of “Boot” & Gain Recognition
As noted above, if the exchange transaction meets all the requirements of IRC
§1031, no gain or loss is recognized on the transaction. However, where the
taxpayer receives cash or other property that is not like-kind (“boot”) then gain, if
any, to the recipient is recognized, but not in excess of the boot [Treasury Reg. §
1.1031(b)-1(a)].
Philadelphia tax treatment of IRC § 1031 transactions
The City of Philadelphia does not have an ordinance that specifically adopts IRC §
1031 treatment for the non-recognition of capital gains on the sale or exchange of
like-kind property. Both the Philadelphia Code and Revenue Department regulations
are silent as to this specific federal statute. To the extent that it is not required
under the Philadelphia Code, the Department of Revenue will not recognize IRC §
1031 on like-kind exchanges.
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BIRT – Gross Receipts portion of the tax
BIRT Regulation Section 324 - Sale of Capital Assets states: (e)xcept as otherwise
provided, the gains (not gross proceeds) resulting from the sale of capital assets, such as
plant, machinery and equipment, furniture and fixtures, vehicles, etc., are to be included
in the tax base if the property is located in Philadelphia at the time of sale. … In
computing the gains or losses from the sale of a capital asset, the cost of the asset, less
allowable depreciation, is deductible from the gross proceeds of the sale. There is no
provision in the BIRT regulations that allows IRC § 1031 tax- free exchange
treatment when reporting gains from the sale, exchange, or other disposition of
property. Therefore, taxable gross receipts will include the net realized gain on the
sale or exchange of the asset.
BIRT – Net Income, Method I versus Method II
Taxpayers that originally elect to report net income under Method II must use IRC §
1031 for purposes of reporting Net Income – provided IRC § 1031 is used to
determine Federal taxable net income for the sale/ exchange transaction. The
definition of Net Income under Philadelphia Code § 19-2601 for Method II is (t)he
taxable income from any business activity as returned to and ascertained by the Federal
Government prior to giving effect to the exclusion for dividends received and net
operating loss… Since IRC § 1031 is a provision used to determine taxable income on
a federal basis, it must be followed under BIRT Income Method II.
Taxpayers who utilize BIRT Income Method I cannot use IRC § 1031 due to BIRT
Regulation 403 – Net Income Method I which states: (t)he rules and regulations
applicable to determining taxable net profits for the Net Profits tax imposed in Chapter
19-1500 of The Philadelphia Code shall be the rules and regulations applicable to
determining taxable net income for Net Income Method I.
Net Profits Tax
For purposes of calculating the Net Profits Tax (NPT), Income Tax Regulation 101(i)
defines Net Profit as the net gain from the conduct, operation or prosecution of a trade,
business, profession, enterprise, or other activity… Net Gain is defined under Income
Tax Regulation 101(h) as cash, credit, property, remuneration, or consideration that is
realized (emphasis added) after allowance for all expired costs and expenses which are
ordinary, necessary, and reasonable as measured in accordance with a cash or strict
accrual accounting system. Net gain shall include the disposition of assets occurring
as part of the normal operations or termination of the business (emphasis added).
Updated 20220915
