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Moroney v. Director, Division of Taxation

376 N.J. Super. 1, 868 A.2d 1132 (App. Div. 2005)

TAXATION; SALES—In calculating the income tax to be paid on the sale of property, the federal adjusted basis must be increased by the cumulative amount of allowed and allowable depreciation deductions that were not utilized by the taxpayer in computing net income from the property in the years of ownership.

In these two unrelated cases, one aggrieved property owner bought a property in 1986 and in each year of ownership its operating expenses surpassed rental income from the property. The other bought property in 1985 and in 1999. It was seeking a tax refund that reflected the net income received from the property. When the Director of the Division of Taxation did not provide the property owners with a net-income analysis that reflected their expectations, each sued the Director for incorrectly calculating unused depreciation on their properties. The Director contended that the Tax Court incorrectly utilized the holding in Koch v. Director, Division of Taxation, 157 N.J. 1, 9 (1999) when it decided to set aside a deficiency assessment to the first owner and to refund taxes previously paid by the other owner.

In Koch, the New Jersey Supreme Court held, in pertinent part, that basing income tax on more than what a property owner has gained in a sale is a tax on a return of capital. That would be taxing neither economic recovery nor gain of past tax benefits. Thus, this sort of income tax is contrary to the intent of New Jersey’s Legislature. Here, it was the Director’s contention that the Koch holding did not apply to depreciation deductions and that the lower court was therefore in error when it rendered its decision.

The Appellate Division disagreed, holding that the Koch decision provided adequate support for the lower court’s decision to compute unused depreciation by attaching out-of-pocket expenses to income before depreciation. Additionally, the Court held that the Director incorrectly employed the federal adjusted basis to tax the disposition and sale of the two properties, therefore incorrectly deducting depreciation before operating expenses.


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