NJ Capital Gains Tax on Selling a Rental Property

When selling a rental property in New Jersey, the profit you realize is a capital gain subject to taxation at both the federal and state levels. The federal government has a specific set of rates for capital gains, which differ from how New Jersey treats the same income. The transaction involves calculating your gain, identifying the correct tax rates, and following state procedures for reporting the sale. Both jurisdictions have their own forms and timelines that must be followed to ensure compliance.

Calculating the Taxable Gain on Your Rental Property

To determine your tax obligation, you must first calculate the taxable gain. The formula is the property’s selling price minus its adjusted basis. The selling price is the gross sales price reduced by selling expenses you incur, such as real estate commissions, attorney fees, and realty transfer fees, effectively lowering the amount of your recognized gain.

A property’s initial cost basis is what you originally paid for the asset. This figure starts with the purchase price and is increased by acquisition costs like title insurance, legal fees, and transfer taxes you paid as the buyer. Meticulous record-keeping from the time of purchase is important for accurately establishing this starting point.

The basis of your property changes over time. Capital improvements increase your adjusted basis, as they add to the property’s value or prolong its useful life, such as adding a new roof. Routine repairs, like painting a room, are maintenance expenses and do not get added to your basis.

Depreciation is another factor that reduces your adjusted basis. The IRS allows you to deduct a portion of your property’s cost basis each year, which for residential rental properties is calculated over 27.5 years. This annual deduction lowers your taxable rental income but also reduces your property’s basis, which increases your taxable gain upon sale.

The IRS requires you to account for all depreciation you were entitled to claim, not just the amount you actually deducted. This is the “allowed or allowable” rule. For instance, if you were entitled to $50,000 in depreciation, your basis is reduced by that amount even if you never claimed the deductions on your tax returns. This adjustment is mandatory and impacts the amount of gain you report.

Applicable Federal and New Jersey Tax Rates

Federal tax law distinguishes between short-term and long-term capital gains based on your ownership period. If you owned the rental property for one year or less, the profit is a short-term capital gain and is taxed at your ordinary income tax rates.

If you owned the property for more than one year, the profit is a long-term capital gain taxed at federal rates of 0%, 15%, or 20%. For 2025, the 0% rate applies to single filers with taxable income up to $49,230. The 15% rate applies to those with income between $49,231 and $541,450, with the 20% rate applying to income above that.

A federal rule applies to the portion of your gain resulting from depreciation deductions. This part of the gain, known as “unrecaptured Section 1250 gain,” is taxed at a maximum rate of 25%. For example, if your total gain is $100,000 and $30,000 is from depreciation, that $30,000 is taxed at the 25% rate, while the remaining $70,000 is taxed at the standard long-term rates.

New Jersey’s tax treatment of capital gains differs from the federal approach. The state does not offer a separate, lower tax rate for these gains. The entire taxable gain from your rental property sale is treated as ordinary income, added to your other income, and taxed at New Jersey’s progressive rates, which range from 1.4% to 10.75%.

Reporting the Sale and Paying Tax in New Jersey

In New Jersey, reporting a real estate sale involves steps at closing and when filing your annual tax return. The state requires an estimated tax payment at closing, handled through GIT/REP forms, which are necessary for recording the deed.

A non-resident seller must make an estimated tax payment at closing equal to the greater of 2% of the sale price or 8.97% of the net gain. Resident sellers may be able to use Form GIT/REP-3, the Seller’s Residency Certification/Exemption, to avoid withholding at closing and instead pay the tax with their annual return.

The payment made at closing is an estimated tax payment, not the final amount owed. You must report the full details of the sale on your annual New Jersey Gross Income Tax Return, Form NJ-1040 for residents or NJ-1040NR for non-residents. The gain is reported on the schedule for “Net Gains or Income From Disposition of Property.”

When you file your annual return, you will claim a credit for the estimated tax payment made at closing. If this payment is less than the total tax liability calculated on your return, you will owe the remaining balance. If the withholding was insufficient, you might need to make quarterly estimated tax payments to avoid an underpayment penalty.

Special Considerations for Property Sales

1031 Exchange

A 1031 exchange allows an investor to defer capital gains tax by reinvesting the proceeds from a sale into another “like-kind” investment property. Both the sold and replacement properties must be located within the United States and held for investment or business purposes.

This strategy has strict timelines. From the closing date of your original property, you have 45 days to identify potential replacement properties in writing. You then have a total of 180 days from the initial sale date to close on the purchase of an identified property.

Sale of a Former Primary Residence

If a property was used as both a primary residence and a rental, you may be able to exclude a portion of the capital gain from tax under Section 121. The rule allows single filers to exclude up to $250,000 of gain and married couples filing jointly to exclude up to $500,000. To qualify, you must have owned and lived in the home as your main residence for at least two of the five years before the sale.

This exclusion does not apply to the portion of the gain from depreciation deductions claimed after May 6, 1997, which must be recaptured as taxable income. Additionally, if you acquired the property through a 1031 exchange and converted it to your primary residence, you must own it for five years before using the exclusion.

Installment Sale

If you finance the sale for the buyer and receive payments over more than one year, you can use the installment sale method. This allows you to report the taxable gain proportionally as you receive payments, spreading the tax liability over several years. You must file Form 6252, “Installment Sale Income,” with your tax return each year you receive a payment.

Any gain attributable to depreciation recapture must be reported as income in the year of the sale. This portion cannot be spread out over the installment period.