19 Dec Should I rent in N.J. to avoid the exit tax?

Q. Several individuals I know have sold their primary residences recently in New Jersey and rented in the state for a year before relocating to other states. They said it saved them substantial money on their exit tax. Would that be a good strategy?
— Planning

A. Let’s first discuss the exit tax.

It’s not actually a separate tax, but a withholding of tax owed on a home sale. It’s a strategy by New Jersey to make sure home sellers don’t leave the state without paying what’s due on the sale. More on that in a moment.

When you sell a home in New Jersey, you’re required to pay capital gains taxes on any profits from the sale above the normal exclusion, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

He said this is true whether your home is a principal residence, second home or investment property.

New Jersey residents who have occupied their primary residence for at least two of the last five years can exclude up to $250,000 of the gain for single tax filers and up to $500,000 of the gain for those filing jointly, he said.

“The New Jersey exit tax is really a misnomer as many people assume it’s an additional tax or special tax imposed when you sell your property,’ DeFelice said. “The truth, however, is that the exit tax is merely a prepayment of the estimated tax you owe on the sale of your property.”

He said the estimated tax is paid in advance, either before or at closing, and held in escrow. The tax is then settled when you file your state income tax return, he said.

Whether you remain a New Jersey resident or move out of state, you will still be required to pay tax on any of the gains, he said. The only distinction being when, not if, the tax is paid.

Your residency is important because it leads to different requirements for that tax, DeFelice said.

Residents are defined as those who sell a home in New Jersey and maintain residency within the state. Nonresidents are defined as those who sell a home in New Jersey and establish residency out of state. Part-year residents — those meeting the definition of either a resident or nonresident for only part of the year — are also considered nonresidents.

“The New Jersey exit tax requires non-residents to withhold at closing either 8.97% of the profit/capital gain you make on the sale of your home or 2 percent of the total sale price: whichever is higher,” DeFelice said. “Later, when you file your New Jersey tax return, the actual capital gain tax you owe will be deducted from your estimated tax payment — with any remaining monies refunded to you.”

Even if you sell the home at a loss or in the absence of a capital gain, non-residents are still required to make an estimated tax payment of 2% of the sale amount, he said.

“Under these conditions, you won’t owe any tax and will receive the entire 2% back when you file your New Jersey tax return,” he said.

If you remain a New Jersey resident by renting in New Jersey for a year prior to relocating to another state, you’ll need to file a GIT/REP-3 form at closing. This will exempt you from paying estimated taxes at the time you sell your home, he said. Instead, any applicable taxes on sales gains are reported on your New Jersey Gross Income Tax Return.

“It is important to be aware of how much cash you will walk away from the closing with when you sell your home,” he said. “However, just realize that staying in New Jersey won’t eliminate any tax consequences you may have. It is just delaying the inevitable.”

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This story was originally published on Dec. 19, 2023.

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