Q. We own a home in New Jersey and for the last two years it’s been our primary residence. We are relocating out of New Jersey and plan to rent out the home and then sell it in the next three years. We believe we meet the rule for living in the home for two out of the five past years to avoid capital gains tax on the sale, but when I am out of state and selling the home, are there any other taxes we need to be aware of? The home has appreciated over $500,000 since the time we bought it.
A. There are several items you’ll need to be aware of before you move on with your plan.
When you begin to rent your New Jersey residence, you are converting the home to a business asset and it will no longer be taxed as a personal residence, said Neil Becourtney, a certified public accountant and tax partner with CohnReznick in Eatontown.
He said you’d need to calculate depreciation of the building (27.5-year life – 3.636% annually).
“Then, even if your gain on the future sale of the residence is less than $500,000 – which would be fully excludible from income if the two out of the preceding five-years ownership and use test is satisfied – you would still be taxed on the aggregate amount of the depreciation deductions due to the depreciation recapture rules,” he said .
You note that your home has appreciated in value by more than $500,000 since its purchase.
But when calculating your gain, you need to subtract all closing costs including realtor commissions, attorney fees and transfer taxes. This will reduce the amount of your gain for tax purposes, Becourtney said.
“Furthermore, you also may not be considering the cost of costly improvements made to the home over time,” he said. “Taking all these additional factors into account, you may find that the amount of your actual gain for tax purposes may be below $500,000.”
Your relocation to another state from New Jersey will result in you becoming a New Jersey nonresident.
The income that is solely connected to New Jersey, such as wages derived from New Jersey employment, ownership interests in certain pass-through entities such as S corporations that are conducting business in New Jersey and any profit you generate from renting your New Jersey residence will then be subject to the New Jersey nonresident tax, he said.
“If you are relocating to a state with an income tax, you may be eligible to claim a credit in your new home state for purposes of that state’s income tax, which reflects the non-resident income tax you pay to New Jersey,” he said. “You also will continue to be required to pay New Jersey real estate taxes on your New Jersey residence for as long as you continue to own it.”
Then there’s the “exit tax,” something we all know about when a taxpayer moves out of the state.
But this is not really a tax for leaving.
Instead, taking your scenario, if you sell your New Jersey residence while being a New Jersey nonresident, a New Jersey withholding tax would be required to be paid at the closing of the sale, equal to the lesser of 2 percent of the gross sales price or 8.97 percent of the calculated gain, Becourtney said.
“Even if there is no taxable gain realized, withholding based on 2 percent of the gross sales price would be required,” he said. “However, the amount would be refunded – assuming there is no other New Jersey source income – upon the subsequent filing of a New Jersey nonresident income tax return.”
If you begin the year as a New Jersey resident and a change of residence occurs during the year, you are subject to New Jersey income tax as a part-year resident: from January 1 through the date your residency ceases, and taxed on the income generated during the part-year period of your New Jersey residency, Becourtney said.
“Generally, any income derived after ceasing to be a New Jersey resident, unless it is sourced to New Jersey, would not be subject to New Jersey income taxation,” he said.
Good luck with your move, and think about working with a qualified tax preparer to make sure you do it right.
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