ASK THE TAX PRO – NEW JERSEY AND THE WASH SALE RULE

Q. I have a question about NJ state tax policy on capital loss.

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For federal tax, there is the wash sale rule. Does the same policy apply to NJ state tax? My situation is that due to the wash sale rule, I cannot claim a lot of my loss on the federal return. If the same rule does NOT apply to state tax, then I have a net loss, which cannot really be deducted in NJ state tax return.

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I am thinking about selling some stocks with loss so that I can claim a net loss in the federal tax return, but I am afraid this will generate a bigger loss that cannot be claimed in state tax return. Is there anything to help the dilemma here? Do you think it is allowed that I use the same wash sale rule so that some loss can be carried over to next year for state tax purpose?

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A. Under the federal “wash sale” rules, the IRS will disallow any loss on the sale of an investment when the same or substantially identical securities are acquired within 30 days before or after the sale. If you sold 100 shares of IBM on November 2nd for a net loss of $1,000.00 and repurchased 100 shares of IBM on November 28th you cannot deduct the $1,000.00 loss.

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When a “wash sale” occurs, the cost basis of the same or substantially identical security acquired within the 30 day period is increased by the amount of the loss that was disallowed under the “wash sale” (the $1,000.00 in the above example). The holding period for the replacement security includes the holding period of the stock you sold.

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As to the New Jersey Gross Income Tax treatment of a "wash sale":

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The instructions for Schedule B of the NJ-1040, which is the NJ equivalent of the federal Schedule D and where you would report Net Gains or Income from the Disposition of Property, clearly states –

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“The basis to be used for computing gain or loss is the cost or adjusted basis determined for Federal income tax purposes.”

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You would use the same cost basis for the investments sold on the Schedule B of your NJ-1040 as you did on the Schedule D of your federal Form 1040. So, if your federal cost basis is adjusted for a “wash sale” so is your NJ basis. The net gain or loss on the sale of the investment is the same on the NJ-1040 as it is on the federal 1040.

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Because the “wash sale” rule reduces your net federal loss on the sale of the investment, so it also reduces your net NJ state loss. This is a good thing. As the NJ state income tax is a “Gross Income Tax”, you are not allowed to deduct a net loss in any individual category of income. And NJ also does not permit any “carryover” of unused net losses.

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If you are selling additional stock to create the maximum $3,000.00 net capital loss on your federal Form 1040, the $3,000.00 net loss is “lost” on the New Jersey return. And if you have a net capital loss from 2007 current year activity of $10,000.00, claim a federal deduction of $3,000.00 on the 2007 return, and “carryover” $7,000.00 to the 2008 federal Form 1040, the $10,000.00 in net losses are “lost” on the New Jersey return. The losses are “lost” forever for NJ state income tax purposes, and there is nothing you can do about this problem. You will never be able to claim a state tax benefit from these losses.

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Check out my posting “CAPITAL GAINS AND NEW JERSEY STATE INCOME TAX”.

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FYI, in the case of property with accumulated depreciation, the New Jersey cost basis, adjusted for depreciation recapture, may be different from the federal basis, as NJ has not accepted certain recent federal depreciation changes. But this will most likely affect the sale of business assets, and therefore will not be included in gains and losses reported on the NJ Schedule B.

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I hope I have been of help.

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BTW:

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(1) Check out my new blog for Schedule C filers THE FLACH REPORT.

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(2) I have posted the answers to my trivia contest at ANYTHING BUT TAXES.

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TTFN