On January 14, 1999, the New Jersey Supreme Court in Koch v. Director, Division of Taxation, reversed a long-standing, state position on the calculation of New Jersey taxable income from the sale of property.
Prior to Koch, New Jersey required that taxpayers use the federal income tax basis to calculate the gain or loss for New Jersey tax purposes on the sale of property despite the fact that the federal basis may have been reduced by items that did not give rise to any New Jersey tax benefit. For example, when a New Jersey taxpayer had losses from real estate (directly or through a partnership), the taxpayer was generally unable to use the losses to reduce New Jersey taxes. At the same time, for federal purposes, the taxpayer could either use the losses or carry them forward. At the time of sale, New Jersey nevertheless required the taxpayer to calculate the gain using his/her federal income tax basis in the property, which had been reduced by any federally-allowed losses.
In Koch, the New Jersey Supreme Court held that the basis used for New Jersey purposes need not be reduced by items that were not deductible for New Jersey tax purposes; therefore, the taxpayer's New Jersey basis in Koch was higher, creating less New Jersey taxable income. This case will have a significant impact, in particular, on taxpayers disposing of commercial real estate (or interests in partnerships owning such real estate) in New Jersey. In addition, if a New Jersey taxpayer filed a New Jersey income tax return that included a gain on the sale of property using the federal income tax basis, the Koch holding may give rise to a refund claim. Refund claims must be filed within the time frame afforded by the New Jersey gross income tax statute of limitations which is generally the later of three years from the time a return was filed or two years from the date the tax was paid. New Jersey taxpayers are encouraged to review their tax records before April 15th to see if they have Koch - type transactions in prior open tax years.
