As a property owner, you may be familiar with the concept of a 1031 Exchange, a transaction that allows investors to defer the payment of capital gains taxes on the sale of investment property. However, if you are a resident of New Jersey, you may also need to consider the state’s Exit Tax when planning a 1031 Exchange.
What is a 1031 Exchange?
A 1031 Exchange, also known as a like-kind exchange, is a tax-deferred transaction that allows investors to sell their investment property and reinvest the proceeds in another property without paying capital gains taxes on the sale. The exchange is allowed under Section 1031 of the Internal Revenue Code, which stipulates that the properties involved must be of like-kind and held for investment or business purposes.
In a 1031 Exchange, the property owner has 45 days from the sale of their property to identify a replacement property and 180 days to close on the purchase of that property. By doing so, the owner can defer the payment of capital gains taxes until they sell the replacement property, at which time they can use another 1031 Exchange to defer taxes again.
What is the Exit Tax in New Jersey?
The Exit Tax is a tax levied by the state of New Jersey on property owners who sell their primary residence or investment property and leave the state. The tax is calculated based on the property’s net gains, which is the difference between the sales price and the property’s original cost, plus any improvements and depreciation deductions.
The tax rate for the Exit Tax in New Jersey is 2% of the net gains, but it can be as high as 10.75% for non-residents. The tax is typically withheld at the time of the sale and credited against the seller’s New Jersey income tax liability. If the tax exceeds the seller’s income tax liability, they may be eligible for a refund.
How does the Exit Tax affect a 1031 Exchange?
If you are a resident of New Jersey planning a 1031 Exchange, you may be subject to the state’s Exit Tax if you sell your property and leave the state within two years. However, the Exit Tax does not apply if you reinvest the proceeds of the sale in another property within New Jersey or if you move out of state after the two-year period has expired.
To avoid the Exit Tax in a 1031 Exchange, it is important to work with a qualified intermediary who can help you identify replacement properties within New Jersey or in other states where you plan to move. By doing so, you can reinvest the proceeds of the sale and defer the payment of capital gains taxes without triggering the Exit Tax.
A 1031 Exchange can be a powerful tool for deferring capital gains taxes on the sale of investment property. However, if you are a resident of New Jersey, you also need to consider the state’s Exit Tax when planning your exchange. By working with a qualified intermediary and reinvesting the proceeds of the sale in another property within New Jersey or after the two-year period has expired, you can maximize your tax savings and minimize your tax liability.
