There are no assets more important to a person than her home. I meet with clients every day who ask me questions about protecting their homes from one perceived issue or another. In this article, I will address some of the legal issues that affect a person’s home and offer my suggestions for preserving your home for yourself and your family.
An issue that brought my attention back to the home is a common comment clients make to me. “My friend just sold her house and moved to another state,” the client will say. “She had to pay the exit tax.”
The belief that New Jersey levies an exit tax against residents who are selling their homes and leaving New Jersey is nearly universally held. The truth is the exit tax is a myth; there is no exit tax in New Jersey.
When a person sells her house, she may realize gain on the sale of the house. For instance, assume that Mrs. Smith purchased her house in 1970 for $15,000. Over the past fifty years, she has made capital improvements to her home, totaling $100,000. Currently, her house is worth $500,000. Mrs. Smith basis in her house would be $115,000—purchase price plus capital improvements. If Mrs. Smith were to sell her house, she would realize a capital gain of approximately $385,000 ($500,000 sales price less $115,000 basis = $385,000 realized gain).
If a person lives in a residence as her primary residence and owns a residence for two of the last five years, she can claim a $250,000 exclusion from gain realized on the sale of the home. A married couple can exclude twice that much or $500,000.
By the way, this brings up another misconception. Many people believe that they do not have to pay capital gains tax—no matter what the amount of gain—if they roll the sales proceeds over to a new house. This rollover exclusion from gain has not existed since the 1990’s. Nowadays, a taxpayer receives a $250,000 exclusion from gain if she lived in the residence as her primary residence and owned the property for two of the last five years. (Once again, a married couple can exclude $500,000 in gain.)
Mrs. Smith has lived in her home since 1970, so she can exclude $250,000 in gain. She has $385,000 in realized gain upon the sale of her home; if we subtract her $250,000 exclusion, Mrs. Smith would owe capital gains tax on $135,000 of gain ($385,000 realized gain less $250,000 exclusion = $135,000 taxable gain). The gain would be taxed at long-term capital gains tax rates.
The exit tax that a departing New Jersey resident must pay is really just an estimated capital gains tax. At the time of sale, either 8.97% of the net gain (the $135,000) or 2% of the total sales price ($500,000) is held as an estimated capital gains tax, whichever is higher. If there is an overpayment of the tax based upon this estimated withholding, then the taxpayer will receive a refund when she files her final New Jersey income tax return.
So, there is no exit tax. Just the payment of an estimated tax of which the taxpayer may receive a partial or total refund depending upon the amount of tax the taxpayer owes.
Many of my clients are also concerned about protecting their home from the devasting costs of long-term care, such as care in a nursing home; a nursing home can cost upwards of $15,000 a month. In order to protect the home, I frequently recommend that the client place ownership of their home in an irrevocable trust with their children as trustees and beneficiaries of the trust. The parent retains the right to live in the house for the remainder of her life and the obligation to pay all the carrying costs associated with the house.
By transferring ownership of the house to the trust, the parent removes the house from her name and protects the house from long-term care costs. The transfer is subject to the Medicaid five-year lookback, so the transfer should be done sufficiently in advance of the parent needing long-term care. The trust protects the house from the children’s potential problems; for instance, if any of Mrs. Smith’s children get sued or divorced or pass away, the child’s personal problems will not affect Mrs. Smith’s home.
The New Jersey “exit tax” is often misunderstood and frequently causes unnecessary concern for home sellers. Understanding how the law actually works can help you make informed decisions and avoid surprises during the sale of your home.