23 May Will we get a refund of tax withheld when we sold this home?

Q. My husband’s parents lived in New Jersey for 35 years, and when they passed in 2016, we inherited the house. We sold the home in 2022 and prepaid the New Jersey estimated withholding tax. Are we entitled to a refund of that tax? We lived in the New Jersey home part time — more than 30 days a year — so I think we’d be considered part-time non-residents. We currently live in Pennsylvania.
— Hoping for a refund

A. The tax withheld at the sale of a home — the so-called exit tax — is confusing for many sellers.

The short answer to your question is the famous: it depends.

You and your husband should have received a step-up in cost basis on the home when you received the inheritance based on the approximate value of the property as of the date your in-laws passed away in 2016, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

Add to that any home improvements you’ve made during the time you owned the house, and you’ll have your adjusted cost basis, he said.

However, he said, in order to qualify for an exclusion on capital gains, you must be able to show you’ve used the property as a principal residence in two of the last five years.

If that is the case, you will qualify under Section 121 of the Internal Revenue Code which excludes up to $500,000 of gain for married taxpayers or $250,000 for single taxpayers, DeFelice said.

“Based on your question, it sounds like you did not use the home as your principal residence and only lived there part-time,” he said. “If this is the case, you will owe capital gains tax both at the federal and New Jersey state level, assuming the home was sold for more than your 2016 step-up adjusted cost basis.”

For federal taxes, the amount of gains will get taxed at 0%, 15%, or 20% depending on your income and filing status, he said. The State of New Jersey follows the federal home sale capital gain exclusion rules, so if you don’t qualify, you will owe capital gains tax to New Jersey as well, he said.

At the state level, New Jersey taxes capital gains as ordinary income, with rates that range from 1.4% to 10.75%. It should be noted that the 10.75% rate only applies once your taxable income exceeds $5 million, he said.

“That being said, when New Jersey residents, part-time residents, and non-residents sell their homes, they must pre-pay a standard tax rate on the profit from the sale,” he said. “New Jersey withholds either 8.97% of the profit or 2% of the selling price, whichever is higher.”

That’s what’s known as the exit tax, but it’s really just an estimated tax.

“This estimated tax is adjusted when the seller files a New Jersey tax return for the year of the sale,” he said. “Depending on what you actually wind up owing, your tax may be refunded as appropriate at the time of filing.”

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This story was originally published on May 23, 2023.

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.