Will couple owe the ‘exit tax’ on this home sale?

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Q. If a wife owns a home that the husband and wife have used as a primary residence for 20 years, then they move out of state while the home is on the market, does the home qualify for an exemption from the withholding at closing with GIT/REP3, option 2?
— Seller

A. You’re asking about the so-called exit tax, which is actually an estimated tax that’s withheld on the sale of certain homes.

The reason for the tax withholding is so New Jersey can be sure those who move out of the state will file their final non-resident tax return.

There are exemptions to the tax.

Let’s look at that exemption from the withholding tax.

Option 2 states: The real property sold or transferred is used exclusively as a principal residence as defined in 26 U.S. Code section 121. Code section 121 is the area of the Internal Revenue Code that allows for the exclusion of gain on the sale of a principal residence. IRS Publication 523 explains that a principal residence is one that is the taxpayer(s) main home. In this case, the home is the couple’s main home.

The FAQs on Gross Income Tax on Real Property transfers on the N.J. Division of Taxation website says that if you qualify for the gain exclusion and the requirements outlined in the Internal Revenue Service Publication 523 are met, you can be exempt from this withholding tax.

However, the FAQ further states that the entire gain must be excluded from gross income, said Laurie Wolfe, a certified financial planner and certified public accountant with Lassus Wherley, a subsidiary of Peapack-Gladstone Bank, in New Providence.

We’ll get to that in a moment.

So can you exclude the gain on the sale of this home?

Wolfe said a married couple can exclude up to $500,000 of gain. She looked at whether you meet the five-step eligibility test laid out in Publication 523.

Step 1: Determine if they are automatically disqualified. If they acquired the property through a like-kind exchange in the past five years or they are subject to expatriate tax, then they would not be eligible for the gain exclusion, Wolfe said.

2. Step 2: They must meet the ownership test. If they owned the home for at least two of the previous five years, ending on the date of sale, they meet this requirement. For a married couple filing jointly, only one spouse must meet this requirement. “This is especially important in this case, where only the wife owns the property,” she said.

Step 3: They must meet the use test. If they owned the home and used it as their principal residence for at least two of the previous five years this test is met. Unlike the ownership test, each spouse must meet the use test, Wolfe said.

Step 4: Determine if they previously excluded a gain in the two years prior to the closing date on this property. They’ve lived in this property for 20 years, so this is not applicable, she said.

Step 5: This step has seven exceptions to the eligibility test, and they don’t apply to you.

“The couple in this case would appear to meet the eligibility tests and would be entitled to exclude up to $500,000 of gain on the property,” Wolfe said.

One final stipulation for exemption from the New Jersey withholding tax on the sale is that the entire gain must be excluded, she said.

“So, if the gain exceeds $500,000, then they are not exempt from the withholding,” she said. “The withholding would be the greater of 2% of the sales price of the home or 8.97% of the gain on the sale.”

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This story was originally published on April 24, 2020.

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