Capital Gains Tax When You Sell a Home in New Jersey: The $250,000 and $500,000 Rule and What NJ Adds

Why long-time owners in these towns need to read this

The exclusion is $250,000 or $500,000. Over the past 12 months the median recorded sale in Saddle River was $2.45M and in Ridgewood $1.16M, from the state's deed records. An owner who bought decades ago can have a gain well past $500,000. See your town on the market report.

The federal exclusion: three tests

IRS Publication 523 sets out the eligibility test:

• Ownership: you owned the home for at least 24 months of the five years before the closing. For a married couple filing jointly, only one spouse has to meet this.
• Residence: you lived in it as your main home for at least 24 months (730 days) of those five years. The months do not have to be consecutive, and each spouse must meet this test for the full $500,000.
• Look-back: you did not exclude gain from another home sale in the two years before this one.

What New Jersey does

New Jersey follows the federal rule. In the Division of Taxation's words, your capital gain on the sale of a primary residence is calculated the same way as for federal purposes, any amount taxable federally is taxable for New Jersey, and single filers can exclude up to $250,000 and joint filers up to $500,000, regardless of age, as long as you owned and lived in the home for two of the five years before the sale.

The difference is the rate. New Jersey does not distinguish between short-term and long-term gains: the taxable gain is added to your income and taxed at your regular New Jersey rates, the highest of which is 10.75%.

Federal rates on the rest

Federal long-term capital gains are taxed at 0%, 15% or 20% depending on taxable income. Gain that comes from depreciation you took on part of the home used for business or rental is taxed at up to 25%.

The 3.8% net investment income tax can also apply when modified adjusted gross income is above $250,000 for married couples filing jointly or $200,000 for single filers. It does not apply to the portion of a home sale gain you excluded.

A worked example

A married couple bought in 2004 for $700,000 and spent $250,000 over the years on documented improvements, so their basis is $950,000. They sell for $2,000,000. State transfer fees at that price are $41,675; for this example we assume $100,000 more in commission and attorney fees. Their gain is $908,325. After the $500,000 exclusion, $408,325 is taxable, federally at capital gains rates and in New Jersey at ordinary income rates.

Improvements raise your basis and lower the gain. IRS Publication 523 defines them as work that adds to the value of your home, prolongs its useful life or adapts it to new uses; repairs and maintenance that only keep it in good condition, like painting or fixing leaks, do not count. Keep the invoices.

Federal and New Jersey, side by side

The same exclusion, different treatment of what is left:

If you do not meet the two-year tests

You may still get a partial exclusion. IRS Publication 523 allows one when the main reason for the sale was a change in workplace location, a health issue, or an unforeseeable event. The excluded amount is reduced; Publication 523 has the worksheet.

If the home was transferred to you by a spouse or former spouse, including in a divorce, you can count the time your spouse owned it as your own ownership, but you must meet the residence test yourself.

Records to keep before you list

Your accountant will need these to calculate basis and gain:

• Your purchase closing statement.
• Invoices and permits for every addition and improvement.
• Records of any part of the home used for business or rented, and depreciation taken.
• Any prior home sale where you used the exclusion, with the date.

Situations worth a call to your accountant first

Get advice before you list if any of these apply:

• Widowed: a surviving spouse who has not remarried can still claim up to $500,000 if the home is sold within two years of the spouse's death and the other conditions are met.
• Part of the home was a rental or a home office: the gain may have to be split, and depreciation is taxed separately.
• You are moving out of New Jersey: you will also need to deal with the State's estimated tax at closing. If your whole gain is excluded under Section 121, you can claim an exemption. See selling and moving out of state.
• You are selling a second home or investment property: the exclusion does not apply, but a 1031 exchange may for investment property. See selling commercial property in North Jersey.