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Delaware Restricts Exemptions from Tax on Real Estate Sales by Nonresidents

The state of Delaware has newly interpreted its 2010 law imposing a tax on nonresident sellers of Delaware real property to mean that in order to be exempt as a “resident” an individual must have resided in Delaware on every day of the year of sale.  Consequently, only sales on December 31 of each year will qualify for the resident exemption, and employees who are relocated from Delaware and sell their home there may claim exemption from tax only if the capital gain is within the exemption amounts for the homesale capital gain exemption.

Although the Delaware statute refers to “withholding” of income tax on sales or exchanges of real estate by nonresident entities or individuals, it does not actually require any withholding, and neither the transferee of real estate nor any of the parties such as closing attorney, real estate agent, or title insurers are liable for any tax.  Rather, the statute requires every seller to file an estimated tax return and submit payment of any taxes estimated to be due, using the highest marginal rate.  Form 5403 is used for this purpose.  The Recorder of deeds is required to receive the estimated tax return, and the tax payment, before the Recorder records title to the property.  Consequently, no transfer of title may take place unless and until the seller complies with the law.

Form 5403 allows the seller to claim exemption from tax because the seller is a resident of Delaware.  It also allows for exemption if the gain is excluded from income.

The Delaware law, however, has a unique statutory definition of a resident individual.  A “nonresident individual” is defined as an individual who is not a resident individual of Delaware “for the individual’s entire tax year.”  The interpretation of this provision was initially unclear.  It might be interpreted to mean that all transferees moving out of Delaware and selling their homes would be treated as nonresidents, but Worldwide ERC® took the position it should be interpreted to mean only that a nonresident individual is one who was not a resident of Delaware at any time during the year, and until recently the state apparently accepted that interpretation.  

Although Worldwide ERC® continued to urge this interpretation to the State Division of Revenue, for 2019 the Division revised the Form 5403 and advised that the statute must be interpreted to require actual physical residence for the entire year.   Consequently, departing sellers are treated as nonresidents unless the departure occurred December 31, and to avoid tax, they will have to use Form 5403 to claim the capital gain home sale exclusion under section 121 of the Internal Revenue Code.  This is somewhat more restrictive than the rules in many of the states with similar laws, which require only that the home sold be the principal residence of the seller, or that make it explicit that the seller need be a resident only at the time of sale.

Unfortunately, the revised Form 5403 does not make this interpretation of “resident” explicit, either on the form or in its instructions.  Worldwide ERC® members must make sure that Delaware transferees are aware they cannot claim exemption from the tax as residents unless the sale took place on December 31.  

How This Impacts Mobility

The new Delaware interpretation of its law will require that Delaware transferees who sell their home claim exemption from the Delaware tax on nonresident sellers only if all of the capital gain on the home is exempt from tax ($250,000 for singles, $500,000 for married couples).  That rule is more restrictive than the rules in any of the other 15 states that have laws imposing withholding on real estate sales by nonresidents.

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