Does Changing Your State of Domicile Allow You To Avoid Paying Capital Gains Tax?
As individuals approach retirement, they will often ask the tax question, “If I were to move to a state that has no state income tax in retirement, would it allow me to avoid having to pay capital gains tax on the sale of my investments or a rental property?”. The answer depends on the following variables:
What type of asset did you sell?
When did you sell it?
What are the requirements to change domicile to another state?
Selling A Rental Property
We will start off by looking at the Rental Property sale scenario. If someone owns an investment property in New York and they plan to move to Florida the following year, would it be better to wait to sell the property until after they have officially changed their domicile to Florida to potentially avoid having to pay state income tax on the gain to New York? Or would they have to pay tax to New York either way?
Unfortunately, it is the latter of the two. If you own real estate in a state that has income tax and your property has gone up in value, you’ll have to pay tax on the gain to that state when you sell it—regardless of where you live. When someone pays tax to a state other than their state of domicile, they normally receive a credit for the tax paid to offset any tax owed to their state of domicile and avoid double taxation. But that raises the obvious question: What if the state of domicile has no income tax? What happens to the credit? Answer: it’s lost. In the example of someone domiciled in Florida—a state with no income tax—who sells a property in New York, which does have a state income tax, they would owe tax to New York on the gain. However, because Florida has no income tax, there would be nothing to offset, and the credit for taxes paid to New York is effectively lost.
Selling A Primary Residence
While selling a primary residence follows the real estate rules that we just covered, the one main difference is that there is a large gain exclusion when someone sells their primary residence, that does not apply to investment properties. The gain exclusion amounts are as follows:
Single Filer: $250,000
Married Filing Joint: $500,000
Based on these exclusion amounts, someone filing a joint tax return would have to realize a gain greater than $500,000 before they would owe any tax to the federal or state government when they sell their primary residence. Remember, it’s the gain, not the sales price. If someone purchased a house for $300,000 and sells it for $700,000, there is a $400,000 gain in the property. If they file a joint tax return, the full $400,000 is sheltered from taxation by the primary residence exclusion.
Once the gain exceeds $250,000 for a single filer or $500,000 for a joint filer, then the owner of the house would have to pay tax to the state the house is located in, regardless of their state of domicile at the time of the sale.
Selling Stocks or Investments
If someone has a large unrealized gain in their taxable brokerage account and they are considering moving to a state that has no income tax, they will ask, “If I wait to sell my stock until after I have officially changed my state of domicile, will I avoid having to pay state income tax on the realized gain?” The answer here is “Yes”. This is one of the advantages that investment holdings like stocks, bonds, ETFs, and mutual funds have over real estate investments.
For example, Jen lives in New York and purchased shares of Nvidia a few years back for $10,000, which are now worth $200,000. If she sold the shares now, she would have to pay a flat 15% long-term capital gain at the federal level, and approximately 6% ($11,400) to New York State. However, if Jen plans to move to Florida and waits to sell the Nvidia stock until after she has officially domiciled in Florida, she would still have to pay the 15% long-term capital gains tax to the Feds, but she would completely avoid having to pay tax on the gain to New York State, saving her $11,400 in taxes.
The Timing of The Sale of Stock is Key
When someone changes their state of domicile mid-year, which is most, a line in the sand is drawn from a tax standpoint. For example, if Jen moved from New York to Florida on May 15th, all investment activity between January 1st – May 14th would be taxed in New York, and all investment activity May 15th – December 31st would be taxed (essentially not taxed) in Florida. It’s for this reason that individuals who have taxable investment accounts and are planning to move to a more tax-favorable state within the next few years may be influenced as to when they decide to sell certain investments at a gain within their taxable investment portfolio.
IRA Distribution Taxation
Traditional IRA distributions are taxed at ordinary income tax rates, but the same timing principle applies; any distribution processed prior to the change in domicile would be taxed in their current state, and distributions processed after the change of domicile are taxed or, in some cases, not taxed, in their new state. If Roth conversions in retirement are part of your tax strategy, this is also one of the reasons why individuals will wait until they have become domiciled in the new state before actually processing Roth conversions.
What Are The Requirements To Change Your State of Domicile
The rules for changing your state of domicile are more complex than most people think. It’s not just “I have to be in that state for more than 6 months out of the year.” That may be one of the requirements, but there are many others. So many that we had to write a whole separate article on this topic, which can be found here:
Article: How To Change Your Residency To Another State for Tax Purposes
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
Can moving to a state with no income tax help me avoid paying capital gains tax?
It depends on your income picture and the type of assets that you own. If you live in a state now that has income tax but you pay very little state income tax, moving to a state that has no income tax will have a minimal impact. However, if you specific sources of income, such as investment income or taxable income from Roth conversions, moving from a state that has income tax to a state with no income tax can have a meaningful impact.
Do I still owe state tax on the sale of a rental property after moving?
Yes. If you sell a rental property located in a state that imposes income tax, you must pay tax to that state on the gain, regardless of where you live at the time of sale. You receive a credit on the state tax paid to apply against any state tax due in your current state, but if there is no state income tax in your current state of domicile, the credit goes unused.
How is the sale of a primary residence taxed when moving to another state?
You can exclude up to $250,000 in gains if single or $500,000 if married filing jointly when selling your primary residence, provided you meet ownership and use requirements. Any gain above these thresholds is taxable to the state where the property is located, even if you’ve moved to a no-tax state.
Can I avoid state taxes on stock sales by moving before I sell?
Yes. If you wait to sell appreciated investments such as stocks, ETFs, or mutual funds until after establishing domicile in a no-income-tax state, you can avoid state tax on the capital gains. The timing of your move and the sale determines which state has taxing authority.
How does the timing of domicile change affect investment taxation?
When you change residency mid-year, income earned before the move is taxed by your former state, while income earned after is taxed under the new state’s rules. For example, investment gains realized before moving from New York to Florida would be taxed in New York, but gains realized afterward would not be.
Are IRA withdrawals and Roth conversions affected by state residency changes?
Yes. Distributions from traditional IRAs or Roth conversions made before changing residency are taxed in your former state, while those made afterward follow the tax rules of your new domicile. This timing can be strategically used to reduce state income taxes in retirement.
What are the main requirements to change your state of domicile for tax purposes?
Changing domicile involves more than just spending six months in another state. You must establish clear intent and presence — such as changing your driver’s license, voter registration, mailing address, and location of key assets — to prove your new primary residence for tax purposes.
