Do I have to pay the exit tax after selling house at a loss?

By Karin Price Mueller | NJMoneyHelp.com for NJ.com

Q. I am selling a house in New Jersey which was bought in 2004 at the price of $780,000. I paid off the full mortgage. The house has been rented out for six years, and it just sold for $755,000. I was directed to pay a non-resident tax of $15,000. Do I have to pay that given that I sold the house at a $25,000 loss?

— Seller

A. The exit tax isn’t a separate tax, but instead it’s an estimated tax paid on the sale of a home.

The state instituted the tax so non-residents would file a final state tax return and not skip out on paying what they owe on a home sale.

We’re going to assume this home was your primary residence when you purchased it, and when you moved out six years ago, you converted it into a rental property.

Rental properties are allowed to take a depreciation deduction against rental income, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.

He said depreciation is an acknowledgment that while you are collecting rental income, the underlying structure is aging away.

“The depreciation deduction shelters part of your rental income from taxation,” he said. “This tax savings is to compensate the owner for the wear and tear that the structure, not the land, is undergoing.”

The downside of a depreciation deduction is even though you are saving taxes, your tax basis is being reduced by the depreciation deduction, he said.

Kiely assumed that your improvements were 80% of the original purchase price and the land was 20%. This means that $624,000 was subject to depreciation, he said.

Under current tax laws, you would have taken $135,200 in accumulated depreciation between the years 2105 and 2020. That means your adjusted tax basis is $644,800 ($780,000 – 135,200 = $644,800), which gives you a taxable gain of $110,200, Kiely said.

What happens is you now say “I didn’t depreciate the property?”

“The words in the Internal Revenue Code are your basis is adjusted by the depreciation `allowed or allowable,’” he said. “This means even if you did not take the depreciation deduction, you must still adjust your tax basis downward.”

The $15,000 that was withheld at closing represents 2% of the sales price. You will have to pay both federal and New Jersey taxes on the $110,200, Kiely said.

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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.