1031 Exchange in Kentucky
Kentucky follows federal 1031 exchange rules: the state's income tax calculation begins with federal adjusted gross income, so gain deferred under IRC Section 1031 at the federal level is also deferred for Kentucky purposes. Kentucky taxes capital gains as ordinary income at a flat rate of 3.5% for 2026 (reduced from 4% under 2025 House Bill 1). The state imposes no special withholding on non-resident sellers of real estate, and its real estate transfer tax is a modest $0.50 per $500 of value under KRS 142.050.
Fast Facts
- State Income Tax on Capital Gains
- 3.5% flat rate for 2026. Kentucky taxes capital gains as ordinary income at its flat individual income tax rate, which dropped from 4% to 3.5% effective January 1, 2026 under 2025 House Bill 1. Gain deferred under a valid federal 1031 exchange is also deferred for Kentucky purposes.
- Conforms to Federal 1031
- Yes. Kentucky's income tax calculation starts from federal adjusted gross income, so a Section 1031 exchange that qualifies at the federal level is also recognized for Kentucky income tax. Kentucky has no state-specific 1031 rules or exchange filings.
- Non-Resident Withholding
- None on real estate closings. Kentucky does not impose a mandatory tax withholding at closing when a non-resident individual sells real property (unlike states such as California, Georgia, or Maryland). Non-residents still owe Kentucky income tax on Kentucky-source gain and generally file Form 740-NP.
- Real Estate Transfer Tax
- $0.50 per $500 of value (0.1%), imposed on the grantor (seller) under KRS 142.050 and collected by the county clerk when the deed is recorded.
- Property Tax Rates
- Vary by county and taxing district. Kentucky property tax combines a state rate set annually by the Department of Revenue with local county, city, and school district rates, so effective rates differ significantly by location.
Legislative Updates
Individual Income Tax Rate Cut to 3.5%
House Bill 1 (2025 Regular Session) reduced Kentucky's flat individual income tax rate from 4% to 3.5% effective January 1, 2026, under the state's revenue-trigger mechanism. This lowers the state tax on any recognized (non-deferred) gain from a Kentucky property sale.
IRS Disaster Relief for February 2025 Kentucky Storms (Expired)
IRS announcement KY-2025-02 granted tax relief to taxpayers affected by the severe storms and flooding that began February 14, 2025, postponing various deadlines — including certain 45-day and 180-day 1031 exchange deadlines under Rev. Proc. 2018-58 — to November 3, 2025. That relief period has now ended.
Legal and Tax Considerations
State Income Tax on Capital Gains
3.5% flat rate for 2026 (reduced from 4% by 2025 House Bill 1). Capital gains are taxed as ordinary income; gain deferred under federal Section 1031 is also deferred for Kentucky.
Conforms to Federal 1031
Yes. Kentucky starts its income tax calculation from federal adjusted gross income, so a valid federal 1031 exchange is respected at the state level with no additional Kentucky exchange requirements.
Non-Resident Withholding
None at closing for real estate sales by non-resident individuals. Kentucky-source gain remains taxable to non-residents, who report it on Form 740-NP.
Real Estate Transfer Tax
$0.50 per $500 of value (0.1%), paid by the grantor under KRS 142.050 and collected by the county clerk at deed recording. This tax applies to the deed transfer itself and is not deferred by a 1031 exchange.
State Clawback
None. Kentucky has no clawback statute taxing previously deferred gain when a replacement property located in another state is later sold (unlike California, Oregon, Montana, and Massachusetts).
Required Documentation
- Federal Form 8824 (Like-Kind Exchanges)
- Kentucky Form 740 (residents) or Form 740-NP (non-residents)
- Complete closing statements for both properties
- Qualified Intermediary exchange agreement
Clawback Rule
None
Step-by-Step Process
- 1
Identify Replacement Property
You must identify potential replacement properties in writing within 45 days of selling your relinquished property. The federal identification rules (three-property rule, 200% rule, or 95% rule) apply in Kentucky exactly as they do federally.
- 2
Engage a Qualified Intermediary
Before closing on the sale of your relinquished property, engage a qualified intermediary (QI) to hold the exchange proceeds and prepare the exchange documentation. Kentucky imposes no state-specific QI registration or licensing requirements, so vet your QI's experience, bonding, and fund-security practices carefully.
- 3
Close on Replacement Property
Complete the purchase of your replacement property within 180 days of selling your relinquished property (or by your tax return due date, if earlier). Budget for Kentucky's real estate transfer tax of $0.50 per $500 of value (KRS 142.050), which is imposed on the seller when the deed is recorded and is not deferred by the exchange.
- 4
File Tax Returns
Report your 1031 exchange on your federal return using Form 8824. Because Kentucky's income tax starts from federal adjusted gross income, the federal deferral flows through to your Kentucky Form 740 (or Form 740-NP for non-residents) with no separate state exchange form.
- 5
Research Local Property Taxes
Kentucky property tax rates vary by county, city, and school district on top of the state rate set annually by the Department of Revenue. Before identifying replacement properties, check the local rates and recent assessment history with the county Property Valuation Administrator (PVA), as these carrying costs affect your returns.
- 6
Rural and Agricultural Considerations
Kentucky has a significant agricultural economy, and rural property exchanges carry their own diligence items. If exchanging into farmland or other rural property, review soil quality, drainage, access, and any agricultural-use assessment status, and consider consulting an agricultural specialist in addition to your exchange team.
Timeline Calculator
Enter the closing date of your relinquished property to calculate your 1031 exchange deadlines:
Common Pitfalls
Assuming the transfer tax is deferred
Issue
A 1031 exchange defers income tax on gain, but Kentucky's real estate transfer tax under KRS 142.050 still applies to the deed transfer and is collected at recording.
Prevention
Budget for the $0.50 per $500 transfer tax (imposed on the grantor) on your relinquished property sale, and confirm with the closing attorney or title company who bears any transfer tax on the replacement purchase.
Overlooking property tax variations
Issue
Kentucky property tax rates combine state and local components and can differ meaningfully between counties and taxing districts, which affects the carrying cost of a replacement property.
Prevention
Check rates and assessment practices with the county Property Valuation Administrator (PVA) before identifying replacement properties, and review the property's recent assessment history.
Missing the federal deadlines during a disaster year
Issue
Kentucky has experienced federally declared storm and flooding disasters (for example, the February 2025 storms) that triggered IRS deadline postponements. Investors sometimes assume relief applies to them when it does not, or miss relief they were entitled to.
Prevention
If a federally declared disaster affects your exchange, check the IRS disaster relief announcements for Kentucky and Rev. Proc. 2018-58 with your tax advisor before relying on any extended 45-day or 180-day deadline.
Skipping diligence on rural or farm properties
Issue
Exchanging into Kentucky farmland or rural acreage involves considerations that don't come up with typical commercial or residential rentals, such as soil quality, drainage, road access, and agricultural-use assessment status.
Prevention
Work with professionals experienced in rural land transactions, obtain appropriate surveys and inspections, and verify how the property is classified for property tax purposes before closing.
Frequently Asked Questions
Does Kentucky conform to federal 1031 exchange rules?
Yes. Kentucky’s individual income tax calculation begins with federal adjusted gross income, so gain deferred under a valid federal Section 1031 exchange is also deferred for Kentucky income tax purposes. Kentucky imposes no additional state-specific exchange requirements or filings.
What is Kentucky’s state income tax rate on capital gains?
Kentucky taxes capital gains as ordinary income at its flat individual income tax rate, which is 3.5% for 2026. The rate dropped from 4% to 3.5% effective January 1, 2026 under House Bill 1 (2025 Regular Session). This state tax is deferred along with the federal tax in a qualifying 1031 exchange.
Does Kentucky have any special withholding requirements for non-residents selling real estate?
No. Kentucky does not impose a mandatory withholding at closing on real estate sales by non-resident individuals, unlike states such as California, Georgia, or Maryland. Non-residents still owe Kentucky income tax on any recognized Kentucky-source gain and generally report it on Form 740-NP.
Does Kentucky have a clawback rule for 1031 exchanges?
No. If you exchange Kentucky property for property in another state and later sell that replacement property in a taxable sale, Kentucky has no clawback statute reaching back to tax the previously deferred gain, unlike California, Oregon, Montana, and Massachusetts.
Major Cities
Louisville, Lexington, Bowling Green, Owensboro, Covington, Richmond, Georgetown, Florence, Hopkinsville, Frankfort, Elizabethtown, Nicholasville, Henderson, Paducah, Radcliff
References
Official References
- Kentucky Department of Revenue
- Kentucky Real Estate Commission
- KRS 142.050 — Real Estate Transfer Tax
- Kentucky HB 1 (2025 Regular Session) — Income Tax Rate Reduction
- IRS — Like-Kind Exchanges (Section 1031)
- IRS — Around the Nation: Kentucky (Disaster Relief)
This information is for educational purposes only and is not legal or tax advice. Consult with qualified professionals regarding your specific situation.