October – December 2007 Quarterly Newsletter

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Every issue of The Wall Street Journal seems to have an article about the slumping nationwide housing market and whether we’re . . . already in the midst of . . . going into . . . or going to avoid . . . a recession. Almost any opinion can be supported with quotes from one or more economists. In my 30 years of owning a residential real estate company on Oahu, I’ve experienced several economic cycles. What I’ve found is Hawaii tends to be insulated somewhat from what is happening on the Mainland in view of our location and the fact that our economy is driven largely by tourism and the military. For example immediately following 9/11, tourism from the Mainland plummeted, as major concern existed about flying long distances over water. After awhile, though, tourism from the Mainland surged, as families decided to vacation at home in our relatively safe 50th state rather going on overseas tours to foreign countries.

A discussion of the Oahu Housing Market is on pages 4-5. I’ve included a breakdown of sales activity on Oahu by neighborhood groups. The year-to-date information is more meaningful than the December data. Page 8 is a change-of-pace, a copy of a recent e-mail we received concerning land that is available for sale on Fiji. Anyone have a spare $35 million?

We continue to get periodic questions concerning the Tax Relief Act of 1997. This law enables you to exclude up to $250,000/$500,000 of capital gains (single/married) on the sale of your personal residence providing you have occupied the home for two out of the past five years. The Odds and Ends section of the newsletter on the next two pages is designed to provide answers to the most common questions we’re asked. Included is what identifies a home as being your primary residence if you alternate living in two different areas.

Odds and Ends

Property Tax Assessments: Tax Assessments were mailed in mid-December and for the first time in six years, the total assessed value of residential property on Oahu declined.  The average decrease island-wide was –2.7%.  The average assessed values in all the major areas of Oahu were down except for Town/Urban Honolulu at +3.6%.  The average assessed values in some of the other areas were Windward Oahu –5.0%; East Oahu –4%; Waikiki –1.3%; and Leeward/Central Oahu –2.8%.  Many homeowners could see lower property tax bills in 2008 unless tax rates are raised.  The current tax rate for improved residential is $3.29 per $1,000 of assessed values.

Some 7,000 owners of real estate on Oahu appealed last year’s assessed values and as of mid-December, only about half of those appeals had been resolved.  In my last newsletter, I discussed the appeal I submitted for a one bedroom, hideaway unit my wife and I own in Waikiki.  My appeal was rejected in November.  I have no idea why it was rejected, as I thought the appeal would be a slam-dunk.  I didn’t pursue it, though, as strange things sometimes happen when you least expect them.  In November, we also got a query out of the blue from someone familiar with our unit who owns in the building and wanted to know if we were interested in selling.  Our high-assessed value was useful to us in establishing a selling price.

Saving Taxes When Selling your Home: The Tax Relief Act of 1997 instituted completely different tax provisions applicable to the sale of a primary residence under Section 121 of the Internal Revenue Code (IRC).  The current law, sometimes referred to as “the 121 exclusion,” has been around for about ten years.  However, considerable confusion continues to exist based upon the questions we’re periodically asked.

NOTE: The Stott Team is not licensed to provide legal or tax advice.  Licensed professionals like attorneys or CPA’s should be contacted for such assistance.

A taxpayer can sell real estate held and used as his or her primary residence and exclude up to $250,000 in capital gains taxes if the taxpayer is single and up to $500,000 if the taxpayer is married and filing a joint income tax return.  The taxpayer has to have lived in the property as their primary residence for at least 24 months when a change of employment, poor health, or other unforeseen circumstances have occurred.

For a married couple, only one spouse’s name needs to be on title; however, each spouse has to meet the 24-month occupancy test to qualify for an exclusion of up to $250,000 per spouse.  And, they much file a joint income tax return in the year of sale.  If two individuals are not married but both hold title and each meets the occupancy test, then each co-owner can qualify for the $250,000 exclusion.  If you are in the military or Foreign Service, special rules apply and your 24-month home occupancy may be as far back as 10 years from the date of sale.

In most cases, a taxpayer does not need to have owned the property for more than 24 months if it has been their primary residence for the entire 24 months, as the taxpayer then qualifies for 24 out of the last 60 months.  However, if a taxpayer originally acquired the property via an Internal Revenue Code (IRC) Section 1031 exchange, they must have owned it for at least 60 months to qualify for the $250,000/$500,000 exclusion.  They need to have rented the property for at least a year so it qualifies as investment real estate for the tax deferred IRC 1031 exchange.  And, then they need to have occupied it as their primary residence for at least 24 of those 60 months.

NOTE: A sizable number of absentee owners have used the equity in their Oahu property to purchase a future residence on the Mainland via an IRC Section 1031 exchange and avoid having to pay capital gains taxes.  Contact us or toll-free at 1-800-922-6811 if you would like to discuss what is involved.

A property does not need to be a taxpayer’s primary residence on the date of sale.  If it has been occupied for 24 of the 60 months before the sale, it could have been a rental for up to 36 months.  Home sellers of any age can qualify.  There is no need to buy a replacement primary residence and the 121 exclusion can be used over and over again without limit but not more frequently than once every 24 months.

There is a little known, special provision for separated or divorced spouses.  The purpose of this provision is to enable one spouse to be able to stay in the home for a period of time following a legal separation or divorce rather than having to sell the home for tax purposes, an example might be to postpone selling until the youngest child has finished high school.  If one legally separated or divorced spouse qualifies for the 121 exclusion by occupying the home as their primary resident for at least 24 out of the last 60 months, the other spouse can also qualify for the 121 exclusion when the home is sold, even though the other spouse does not meet the occupancy requirement i.e., both separated or divorced spouses can qualify to exclude up to $250,000 of gain when the home is eventually sold.

If you don’t meet the 24-month occupancy test within the last 60 months prior to the sale, you may still qualify for a partial capital gains exclusion if your move was for (1) job purposes; (2) health reasons; (3) divorce or legal separation; (4) death in the immediate family; (5) unemployment; (6) decreased income leaving the taxpayer unable to pay the monthly mortgage or basic living expenses; (7) multiple births from the same pregnancy; (8) damage to the home from natural or man-made disaster or terrorism; and (9), condemnation, seizure, or other involuntary conversion of the property.

NOTE: If you owned and occupied your primary residence for only 14 months before you moved for job purposes, you would be entitled to exclude capital gains taxes of up to 14/24 or 58.33% of $250,000/$500,000.

The new Mortgage Relief bill just signed into law in December allows a taxpayer a two-year window from date of death of a spouse to claim an exclusion of up to $500,000 vice $250,000.

Establishing a Primary Residence: Many readers of the newsletter alternate between living on the Mainland and in Hawaii.  There are a number of factors used to establish the primary residence for such owners, such as:  (1) the length of occupancy in the two homes; (2) the place of employment; (3) the principal place of abode for family members; (4)  the address used on the taxpayer’s federal and state tax returns; (5) the address where the taxpayer is registered to vote; (6)  the location of taxpayer’s bank(s); (7) the address used for automobile and driver’s license registrations; and (8) the location of the taxpayer’s religious organizations and recreational clubs.

Our experience indicates that most absentee owners that alternate between living in Hawaii and on the Mainland consider their Mainland home to be their primary residence.  If the length of your stay in Hawaii and on the Mainland were reasonably similar, you might want to qualify for 24 months of occupancy in the Hawaii home.  You don’t actually have to be in Hawaii for all 24 months, but you do need to do the things that would qualify the Hawaii home as being your primary residence.  Then, you could sell it, claim the $250,000/$500,000 exclusion and shift your primary residence back to the Mainland.  It is important to keep in mind, though, that you can only have one primary residence at any given time.

Oahu Housing Market

Total sales on Oahu continue to decline. There were 12.590 total MLS sales in 2004; 12,607 in 2005 (essentially the same number); 10,421 in 2006 (down 17.3%) and 9,126 in 2007 (down 12.4%). So, in the past two years sales have declined from 12,607 to 9,126 a decline of almost 3,400 sales or about 28%

At the bottom of the page is a table of the median sales prices since 2003 for both houses and condos (high rises & townhouses). Trends are far more important than the results of any given month. The median or midway sales price is normally used to compare sales prices rather than the arithmetical average (mean), as the mean sales price is susceptible to being biased by very expensive sales. Both the median and mean sales data for the latter part of 2007 are biased high in view of the subprime lending problems, refer to the next paragraph.

Oahu home prices are continuing to decline even though the table below does not necessarily support this. We have a different mix of homes selling today than what sold prior to this past March when subprime lending problems were initially identified. During 2006, almost one-half of the sales to first-time buyers nationwide involved 100% financing. With first-time buyers, often there are two working spouses, so a family may have a relatively high monthly income but limited savings available for a down payment. Recently, sales of lower-end homes have been curtailed by far more stringent qualification standards, Many lenders will no longer make 100% loans and now insist upon a down payment of at least 3-5% which rules out many first-time buyers. The decline in sales of lower-end homes causes the median or midway sales price to increase from where it would have been if there were a similar number or percentage of lower-end homes selling each month; i.e., the mix of homes selling is different now from what is was prior to the subprime lending problems. Looking at it from a different perspective, the $650,000 median sales price for houses in August and September reflects a better or more valuable home than the $650,000 median sales price in May.

Over the years we have found that Paul Brewbaker, the Chief Economist for the Bank of Hawaii, is usually right on the money when it comes to projecting the Oahu housing market. For nearly two years, Brewbaker has been saying that the next period of rising prices will be sometime in the 20-teens; i.e., sometime in 2013 to 2019. His projection fits in historically, as once each decade since 1959 statehood, Oahu has experienced a couple of years of soaring housing prices except for the 1990’s when the state economy tanked; i.e., in the 60’s, 70’s, 80’s, and 00’s, the Oahu housing market had a couple of years of great appreciation. In between, the housing market was relatively flat. If the next soaring Oahu housing market begins in the middle of the 20-teens or in 2016, we should have about eight years of a relatively stable or flat market. Prices will likely continue to decline for several more years. Eventually, though, the housing market will level out and may even start rising slowly prior to 2016.

A Mixed Plate of Talk Story

Dominating the news this past quarter continued to be two stories . . . the UH football team and the Hawaii Superferry.  First football . . . the success of UH during the June Jones era has resulted in various scheduling problems involving likely top-25 teams that don’t want to risk losing a game to UH. The team has found they need to schedule non-conference foes years in advance to have a meaningful selection of games. This past year some past scheduling miscues and the weakness of several conference (WAC) teams had UH playing the weakest Division I schedule in the country. UH ended up being the only major team to go undefeated during the regular season, but it wasn’t easy. Although they were the favorite in every regular season game, twice they went into overtime and at other times, they had to come from behind in the fourth quarter to win. At season’s end they were only the third team from a non-BCS (Bowl Championship Series) conference to make it to one of the five major BCS bowl games. The $4.5 million UH will earn from the Sugar Bowl will be a sizable addition to their shoestring football budget; e.g., the recruiting budget for UH is $50,000 compared to $500,000 for Georgia; plus, UH has to fly recruits/recruiters to and from the Mainland. The UH exposure on the Mainland is already paying dividends; in December, UH got a commitment for the 2008 season from one of the top high school QB’s in the country.

As a non-BCS conference team, UH had to be ranked 12th or higher by the BCS on 12/2 to be guaranteed a BCS bowl berth The BCS uses a combination of various polls and computer inputs to rank teams. UH did fairly well in the polls (AP, USA Today, etc.) but were miserable in the computer rankings in view of their poor strength of schedule. However, as they continued to win, they kept sneaking closer. With one week to go, UH made a major step forward by beating Boise State (11-1) at sold-out Aloha Stadium, thereby winning the WAC title and jumping from 14th to 12th in the BCS rankings, Boise State’s only other loss had been to Washington, the team UH played in their final game before another sold-out Aloha Stadium.

The 1st quarter of the Washington game was as poorly played by UH (three turnovers and a 21-0 deficit) as any quarter in any game in recent history. The game started at 6:30 pm, which made it 11:30 pm on the east coast. Those Mainland fans that turned off their sets at the end of the 1st quarter failed to see UH rally and score three TD’s in the 2nd quarter. At half time it was 28–21; Washington did not score again while UH managed two 4th quarter TD’s to win by a 35-28 margin, the winning score coming with only 44 seconds remaining. We all thought the game was over, but Washington made a miraculous comeback with two long passes. They almost scored in the final seconds before an interception in the end zone ended the game. Mary Lou and I have had season tickets to UH games for about 20 years. We have never seen Aloha Stadium as loud or the stands shaking the way they did that night. UH jumped in the rankings from 12th to 10th thereby sealing their BCS bowl bid. Senior quarterback Colt Brennan won numerous awards and set a raft of NCAA records; he was the first UH athlete ever to be invited to NYC for a Heisman Trophy presentation where he came in 3rd out of the four invitees. An NFL career awaits him.

On New Years Day, UH played Georgia in the BCS Allstate Sugar Bowl and was overwhelmed 41-10. Many people felt that Georgia should have been selected for the BCS championship game. I don’t know if Georgia is bigger and stronger than UH, but they are decidedly faster They demonstrated why they led the SEC in QB sacks, as they plagued Colt Brennan all night long, sacking him eight times for a school and Sugar Bowl record. This football season has seen major upsets every weekend; Georgia made sure it wouldn’t happen to them, as they gave an old fashioned whippin’ to UH in almost every aspect of the game. Sometimes, the upstarts win but most of the time, “flash and sizzle” is just no match for speed and sheer physical power. Despite all the “Believe” signs, UH was just outmatched by Georgia. Still, it was a marvelous season for the UH Warriors . . . only one loss . . . a BCS bowl game that is unlikely to be repeated anytime in the foreseeable future . . . what a marvelous ride Hawaii football fans have had this past year.

The Hawaii Superferry is now operating between Maui and Oahu after a special session of the Hawaii Legislature voted to allow service while the state conducts a lengthy environmental study. Resumption of service to Kauai will take more time, as it was the epicenter of protests that led to confrontations between the protestors and the Coast Guard/police, ultimately forcing the Superferry to stop service to the Garden Island.  Meanwhile, construction of the second ship in Mobile is ahead of schedule and on budget. Service to the Big Island should commence in the first quarter of 2009.  The Superferry Saga became one of the most volatile Hawaii controversies of the past couple of decades. No one likes the idea of legislative actions countering court decisions; however, the unexpected court ruling within days of actually commencing operations that an extensive environmental study had to be completed first would have ended the Superferry in Hawaii. It’s not as if no one knew the Superferry was coming. In all the extensive finger pointing, it appears that everyone involved shares some blame; i.e., the Governor, state officials, judges, state legislators, ferry officials, etc. The fact that an environmental impact statement was not conducted in advance of actual operations may not have been correct; however, it’s easy to see how the state reached a decision that it would not be required, since environmental impact statements were not required for cruise ships, Matson liners, inter-island barges, airlines, etc. Plus, the Superferry does not cross state boundaries. One wonders if any other state requires environmental impact statements for intra-state commerce.

We have recently been involved in the sale of several new luxury condos on Kauai and Oahu and are working on a similar sale on Maui. All the complexes are in the process of being built. The units on Kauai and Maui are oceanfront and in the $1 million plus price range. There are several new complexes on Oahu but only one that is actually oceanfront. Units in the better Oahu complexes start at about $700,000. If this is of interest to you, we can provide you promotional literature as well as input based on our experience.

Here and here are links to a two-part article in the 12/16-17/07 issues of the Star Bulletin on leasehold ownership. A link to an enlarged listing of condos with leasehold expirations in the next ten years is here. I encourage all of you that own leasehold condos to read these articles. The first expiration was The Kailuan, an 18-unit complex in Kailua where the lease expired 12/31/07. The owners have hired a representative and remain up in arms running advertisements, sending mailings, etc. in an effort to save their homes. The hoped for precedent setting process is not occurring.

The ABC TV series “Lost” which is filmed on Oahu has eight new episodes completed, half of what was originally planned for 2008. The series will return the end of January regardless of the status of the Hollywood writers’ strike. The show is scheduled to end in 2011 after three more years of 16 shows per year.

The capital gains tax for taxpayers in a 10% or 15% federal tax bracket was reduced from 5% to 0% on January 1st for what was scheduled to be a 3-year period of time. However, many analysts believe the 0% bracket will be rescinded with other capital gains tax brackets increased following the presidential election. The 0% bracket sounds marvelous until you learn that what the Government gives in one hand, they often take away in the other. Your capital gains are added to your income to determine your capital gains tax bracket. The single 15% bracket ends at $32,550 in 2008. If a single taxpayer has $25,000 of taxable income and $30,000 of capital gains, only $7,550 ($32,550 less $25,000) of their capital gains would be taxed at the 0% bracket . . . There weren’t enough tickets or airline seats to handle all the UH fans desiring to go to New Orleans for the Sugar Bowl. For those that stayed behind, there were TV parties across the state including one at our house. About 90,000 homes lost their cable TV feed for about an hour during the game.

The following e-mail was sent to us via our website; i.e., someone pulled up stott.com, selected “contact us,” loaded their text into our online format and sent us the e-mail. Paul DeDomenico is a real person per Google. Anyone have a spare $35 million?

Subject: Contact Form
Date: Monday, December 10, 2007 12:11PM
From: DolceVitaPaul@aol.com
To: TheStottTeam@Stott.com

Contact Form

Name: Paul DeDomenico
E-Mail: DolceVitaPaul@aol.com
Phone 1: 505-989-4760
Phone 2:

Comments: My wife Anita and I have decided to personally market our private South Pacific Fiji Plantation properties. We have established a 6% finders fee ($2,100,000 at the current list price) incentive to anyone who refers the eventual buyer to us. Our Fiji staff will take care of showings and closing details.

Anita and I purchased our unique Fiji Island Plantation over 37 years go after we successfully marketed Rice-A-Roni for our family corporation. We had intended to develop the Plantation, but then our family purchased Ghirardelli Chocolate Company, and my wife and I spent the next several years creating Ghirardelli Square.

We have over 4 miles of white sand swimming beaches and 806 acres of land that could be developed into 4 or 5 hotels with several hundred separate residences. There are no Fiji income or property taxes for 20 years on tourist related developments. There are no property taxes currently.

We eventually ended up in the macadamia business in Hawaii for some 30 years. We spend most of our time now at our villa in Cernobbio, Lake Como Italy, if we are not at our primary home in Santa Fe, New Mexico. Unfortunately, we are too old now to spend the additional time needed to develop our Fiji Plantation.

Our island was discovered by Captain Bligh who wrote on May 6th, 1789 in the Bounty’s log book: Nothing Can Exceed Its Beauty. He was right.

Since only 8% of the land in the Commonwealth of Fiji is fee simple (the balance is in trust for the Fijian people) our pristine Matana Plantation, with its outstanding unique private beautiful white sand beaches, as unlimited future appreciation potential.

Please check our website http://www.tuitai.com/matana/ for pictures of the Plantation and information regarding the property. There are 4 Freehold titles on the property. We are also willing to consider the sale of titles separately to qualified buyer(s).

Please email if you would like us to send brochures, Paul

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