Moving to a new home is an exciting milestone, but it’s also a major financial event with complex tax implications that most people overlook. While you’re focused on packing boxes and hiring movers, the IRS and state tax agencies are watching. Many common actions taken during a move can trigger unexpected and hidden tax bills that can catch you completely off guard. Understanding these potential pitfalls ahead of time is essential for protecting your finances during this major life transition.
Here are nine reasons your big move could result in a surprise bill from the taxman.
1. Failing the Home Sale Exclusion Ownership Test
The IRS allows most homeowners to exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains from the sale of their primary home. To qualify, you must pass the Ownership Test, meaning you owned the home for at least two of the five years leading up to the sale. If you sell a home you’ve owned for less than two years, you may owe capital gains tax on the entire profit.
2. Not Meeting the Two-Year Use Requirement
In addition to the Ownership Test, you must also meet the Use Test. This means you must have lived in the home as your primary residence for at least two of the five years before the sale. If you owned the home for years but rented it out for the last three, you would fail the Use Test and be subject to taxes on your profit.
3. Forgetting to Account for Home Office Deductions
If you claimed the home office deduction in previous years, you need to be careful. The IRS requires you to “recapture” the depreciation you claimed on that portion of your home. This means the amount you depreciated will be taxed as ordinary income upon the sale, even if the rest of your home sale profit is tax-free. It’s a common and often forgotten tax trap for remote workers and small business owners.
4. Moving to a State with a Different Income Tax Rate
If you’re moving from a state with low or no income tax to one with a high income tax, you need to plan carefully. Your new state will want to tax your income as soon as you become a resident. Furthermore, if you continue to earn income from your old state (for example, from a rental property), you may have to file tax returns in both states, creating a more complicated tax situation.
5. Ignoring State-Specific Exit Taxes
Some states, particularly those with high tax rates, are aggressive about ensuring departing residents pay their fair share. A so-called “exit tax” isn’t a separate tax but rather a state’s effort to tax income you earned while you were a resident, even if you receive the payment after you move. This can apply to things like bonuses, stock options, or deferred compensation.
6. Cashing Out Retirement Funds to Cover Moving Costs
Moving is expensive, and it can be tempting to tap into your 401(k) or IRA to cover the costs. This is almost always a bad idea. Early withdrawals from these accounts are typically subject to both ordinary income tax and a 10% penalty. This can turn a $20,000 withdrawal into a surprise tax bill of several thousand dollars.
7. Misunderstanding Moving Expense Deductions (or Lack Thereof)
Prior to the 2018 tax law changes, many people could deduct their moving expenses. Today, that deduction is gone for everyone except active-duty members of the military. If you’re a civilian, you can no longer write off the cost of your movers, packing supplies, or travel, so don’t count on that deduction to lower your tax bill.
8. Overlooking Capital Gains on High-Value Homes
If you’re fortunate enough to have a profit from your home sale that exceeds the $250,000/$500,000 exclusion limit, the excess amount is taxable as a long-term capital gain. In a hot real estate market, it’s become more common for long-time homeowners to find their gains pushing past these limits, resulting in an unexpected federal and state tax liability.
9. Forgetting to Update Your Withholding Information
After you move and start a new job, it’s crucial to fill out a new Form W-4 for your employer. State and local taxes can vary dramatically from one place to another. If you don’t update your withholding, your employer might not be taking out the correct amount of tax from your paychecks, leading to a large, unpleasant surprise when you file your return.
Unpack Your Tax Situation Before Your Boxes
A successful move requires more than just logistical planning; it requires financial foresight. By being aware of these potential hidden tax bills, you can make smarter decisions about the timing of your sale, the management of your funds, and your new state’s tax laws. Consulting with a tax professional before you move can be one of the smartest investments you make.
Have you ever been surprised by a tax consequence after a major life event like moving?
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