Will we owe the exit tax when we sell this home?

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Q. We are married, ages 66 and 70. We purchased a condo in New Jersey in 2014 and a home in Florida in 2020. Florida became our residence in April 2020 and we are selling the New Jersey condo, where we lived from the time we bought it. We stayed in Florida for eight months in 2020 and three months in 2021. Will we be subject to the exit tax when we sell the New Jersey condo?
— Moved out

A. The exit tax is not an extra tax, but an estimated tax based on the sales price of a home. New Jersey instituted the tax to make sure that nonresidents didn’t leave the state and skirt on paying taxes owed on the home sale.

Form GIT/REP-3 is a form that is used to inform New Jersey that there will be no taxable gain on the sale of a home and that you are claiming exemption from the required estimated tax payment, said Laurie Wolfe, a certified financial planner and certified public accountant with Peapack Private Wealth Management in New Providence.

To qualify under the second listed criteria on that form, the home must be used exclusively as a principal residence as defined in 26 US Code Section 121, she said.

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

Seller’s Assurances number 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,” Wolfe said. “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 up until April of 2020 when they changed their domicile to Florida.”

Wolfe said the FAQs on Gross Income Tax on Real Property transfers on the New Jersey Division of Taxation website say 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 estimated payment at closing, she said.

The FAQs further state that the entire gain must be excluded from gross income. Let’s put a pin in that until later.

A married couple can exclude up to $500,000 of gain, Wolfe said. Let’s see if they meet the 5-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. This does not apply in our case, Wolfe said.

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,” Wolfe 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, she said. Unlike the ownership test, each spouse must meet the use test.

Step 4: Determine if they previously excluded a gain in the two years prior to the closing date on this property. This couple has owned this property since 2014 and there is no mention of another home, so this is not applicable, Wolfe said.

Step 5: This step has seven exceptions to the eligibility test, but that wouldn’t apply here.

It appears you would 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 estimated 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. The withholding would be the greater of 2% of the sales price of the home or 10.75% of the gain on the sale.”

The instructions to this form indicate that the seller must give the completed form to the settlement agent at closing and it will be attached and recorded along with the deed, she said. The closing agent must be made aware ahead of time so that the closing documents properly reflect exemption from this tax, Wolfe said.

Even with this explanation, you should speak to a professional who can advise you based on all the specifics of your case.

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This story was originally published on June 7, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.