How to Avoid Capital Gains Tax in New Jersey

When an asset like a stock or property is sold for more than its purchase price, the profit is a capital gain. This gain is taxed at both the federal and state levels. New Jersey has its own system for taxing these profits that differs from federal rules, which can have financial implications for investors and property owners. However, various legal strategies are available to help minimize or eliminate this tax liability.

New Jersey’s Approach to Capital Gains Tax

New Jersey’s method for taxing capital gains is a core part of its income tax structure. Unlike the federal system, New Jersey does not offer lower tax rates for long-term gains on assets held over a year. All net capital gains, whether short-term or long-term, are treated as regular income and added to other earnings, like wages, to be taxed.

The profit is taxed at the state’s progressive income tax rates, which range from 1.4% to 10.75%. A large gain can push a taxpayer into a higher income bracket, causing the gain to be taxed at that higher rate. This treatment applies to a wide array of capital assets, including stocks, bonds, mutual funds, and investment real estate.

The Principal Residence Exclusion

New Jersey provides a tax relief measure for the sale of a primary home, conforming to the federal rule that allows individuals to exclude a portion of the capital gain. If you meet the specific requirements, you can avoid paying state income tax on a large part of your profit.

To qualify for this exclusion, a taxpayer must satisfy two tests. The ownership test requires you to have owned the home for at least two of the five years leading up to the sale date. The use test mandates that you have lived in the property as your main home for at least two of the five years before the sale, and these two-year periods do not need to be continuous.

The exclusion amounts align directly with federal limits. A single individual who meets the tests can exclude up to $250,000 of the gain. For married couples filing a joint return, this amount doubles to $500,000. For instance, if a married couple has a $450,000 capital gain from their home sale, the entire profit is shielded from New Jersey income tax because it is below their $500,000 exclusion.

Strategic Investment Management

Tax-loss harvesting is a technique that involves selling investments at a loss to offset gains realized from other investments. In New Jersey, capital losses can only be used to offset capital gains within the same tax year. Unlike federal rules, the state does not allow for the deduction of net capital losses against other income, nor does it permit taxpayers to carry forward unused losses to future years.

Another strategy is donating appreciated assets, such as stocks or mutual funds, directly to a qualified charity. By transferring the asset, the donor can avoid paying capital gains tax on the increase in its value. This provides a benefit of supporting a cause while legally avoiding tax on the investment’s growth.

Utilizing tax-advantaged retirement accounts is a foundational strategy for long-term investment. Investments held within accounts such as 401(k)s and Individual Retirement Arrangements (IRAs) grow without being subject to annual capital gains taxes. This tax-deferred or tax-free growth allows investment returns to compound more effectively over time.

Deferring Tax on Real Estate Investments

For investment real estate, specific strategies exist to defer the payment of capital gains tax. One tool for this purpose is a Section 1031 exchange, also known as a like-kind exchange, which New Jersey law accommodates in conformity with federal rules.

A 1031 exchange allows an investor to sell an investment property and reinvest the entire proceeds into a new, similar property without immediately paying tax on the gain. To execute this, strict timelines must be followed: the investor has 45 days from the sale to identify potential replacement properties and a total of 180 days to complete the purchase of the new property.

Another method for deferring tax is an installment sale. By structuring the sale of a property so the seller receives payments from the buyer over multiple years, the capital gain is recognized as the payments are received. This spreads the tax liability over the term of the agreement, which can help manage cash flow and potentially keep the taxpayer in a lower tax bracket.

Inheritance and Capital Gains

Inherited assets provide a way to avoid capital gains tax. When an individual inherits an asset, such as real estate or a stock portfolio, the asset’s cost basis is “stepped up” to its fair market value at the time of the original owner’s death. New Jersey follows this tax-saving provision, found in Section 1014 of the Internal Revenue Code.

This step-up in basis effectively erases the capital gain that accumulated during the lifetime of the person who passed away. For example, if a parent purchased stock for $10,000 that is worth $150,000 on the day the parent dies, the heir who inherits it receives it with a new cost basis of $150,000. If the heir then sells the stock for $150,000, there is no capital gain to report because the sale price and the new basis are the same.