No. If you live on island, then you can manage your own properties. If you are an absentee owner, Hawaii State Law requires that you designate a local agent to act on your behalf. The local agent must live on the same island that the property is located. The local agent does not have to be a licensed real estate agent provided that he or she is only acting as an agent for your property or properties. Therefore, you can have an unlicensed friend or relative manage your rental property as long as he or she does provide this service for anyone else.
If you don’t live on island, we strongly recommend that you conform to this law. If you are in violation of the law, you seriously jeopardize your options should a tenant cause problems. In addition to suffering lost rental income or repair costs, you can be found liable for additional monetary damages.
There are a number of laws, rules, and mandatory disclosures associated with renting a property. If you have a friend or relative manage the property, then you run the risk of violating the rules and putting yourself in legal and financial jeopardy. As a property owner, you can be held liable for the actions of your friend or relative even if you are unaware of their actions.
If your friend or relative does not have any investment property or experience with investment property, you should carefully consider the consequences of having a tenant issue without an experienced professional helping guide you through the process. Hawaii State Law is very tenant friendly and improperly handled issues can result in significant costs to the owner.
Stott Property Management has taken over management of several properties from unlicensed managers. Stott Property Management has encountered many cases where the costs due to unnecessary vacancies, poor debt collection, below market rents, delayed maintenance, missing inventory and condition forms, and poor tenant screening have cost the owner tens of thousands of dollars.
When making a decision to rent a property, an owner should carefully consider any amenity or condition that can raise the risks of a person getting injured on the property. Swimming pools, high decks or lanais, steep inclines, poorly maintained structures, and other potential hazards can increase the chances of someone getting hurt.
If possible, the hazards should be eliminated. If eliminating a hazard is not feasible and the owner still wants to rent the property, then the next best protection is to disclose the hazard to prospective tenants and hire a lawyer to write up a waiver of liability for the tenant to sign with the lease. Please note that there is no defense for failing to properly maintain a property. Safety issues should be fixed immediately.
Placing your investment property in a Corporation or other legal entity may help protect your other assets if a tenant or guest does decide to sue. You may want to discuss your options an attorney before deciding on the best course of action.
If incorporation is not currently feasible, then talk to your insurance agent about a liability umbrella policy. You can receive substantial coverage in the case that you do get sued for damages for a nominal cost.
One of the biggest myths in the rental market may be that owners can attract better tenants by asking a higher rent. In reality, when an owner asks above market rent, the owner limits his or her pool of potential tenants. Most potential tenants look at several properties at the same time. Once the tenants feel that they have seen enough properties, then they will choose the property that provides them the most features and benefits for the most affordable rent.
The best tenants are usually the most informed tenants as well. The tenants with great credit, best jobs, and best prospects also have many more owners that would love to rent to them. Therefore, the best tenant prospects have no problem finding a property for market rent.
Stott Property Management submits a 1099-MISC to the owner and IRS for the year’s rental income. The 1099-MISC requires the Social Security Number in order to identify the taxpayer.
The short answer is no. The State of Hawaii limits a security deposit to the equivalent of one month’s rent. Since Stott Property Management requires a security deposit equal to one month’s rent, a pet deposit is unavailable.
The law does not prevent asking a higher rent for allowing a pet. An owner can weigh the risks of allowing pets against the benefits of receiving more in rent.
Why Does Stott Property Management want to be added as additionally insured on my liability insurance?
Stott Property Management holds liability insurance for any actions by the company and its employees. However, Stott Property Management shall not be liable for the actions of a tenant, owner, or for a defect in the property. The Owner shall provide liability coverage for a possible claim if an accident occurs in the rental property.
Adding Stott Property Management as additionally insured does not cost the Owner any money and helps keep Stott Property Management’s insurance costs manageable.
No. Since a landlord must disclose the addition of General Excise Tax to a prospective tenant, the landlord is in essence just asking for a higher rent. A prospective tenant just looks at what he or she will pay out of pocket to live in a property. Therefore, Stott Property Management just charges rent and then pays the General Excise Tax out of the rental proceeds (unless the Owner decides to file and pay the General Excise Tax him or herself).
Stott Property Management’s Bank requires a minimum balance to minimize bank fees charged to the account. The balance also allows Stott Property Management to pay an Owner’s bills on a case-by-case basis even if there are insufficient funds to pay in any particular month. Stott Property Management may take this action on a temporary basis to help an owner avoid late fees.
A home warranty company, like any other for profit company, is in business to make a profit. In order for a home warranty company to make money, it must collect more in premiums than it pays out in covered repairs. Therefore, over the long run, you are more likely to pay more in premiums than you will receive in warranty work.
Stott Property Management’s experience with home warranty companies is that they do a reasonable job with routine repairs. However, the response to emergency or urgent repairs has often been lacking and Stott Property Management has had to hire another company to repair the problem at the Owner’s expense. Even though a home warranty is often a good feature to offer when selling a home, it is not really appropriate for a long-term rental property.
Call Stott Property Management at 254-5558. If you call after hours or reach our answering machine, please leave your name, address, valid daytime phone number, and a brief description of the problem. We will get back to you no later than the following business day if you call after hours. If an appliance or fixture provided by the owner requires repair and the damage is not caused by the tenant, then the owner will pay the bill.
Please refer to the Emergency Procedures if you think the problem needs immediate attention to prevent further damage to the property. Please note that a broken appliance is not considered an emergency.
You may also submit a service request using your tenant portal. Please include a description of the problem, the room location, person to call, and the best number to call for additional questions and scheduling the repair.
You are responsible for the rent through the length of your lease. Call Stott Property Management and we will work with you to find a qualified tenant as quickly as possible. You will be charged for the time the unit is vacant, any difference in rent through the end of the lease if we can’t rent it our for the amount specified in your lease, advertising costs, and credit report fees.
If you are in the military and receive orders to leave the island, then you must give Stott Property Management 28 days written notice and a copy of your orders.
If you are a month-to-month tenant, then you must provide 28 days written notice.
If you have just moved in, then call Stott Property Management at 254-5558and we’ll discuss remedies. If you have been living there for a while, then it is your responsibility to take care of the problem.
If you suspect that the bugs are termites, please call Stott Property Management at 254-5558. We will have someone check out the problem and if it is termites, will coordinate remedies with you and the owner.
The lease requires that you notify us if you are going to be out of town for more than five days.
If you are going to be out of town for a few weeks, please make sure you mail your rent check ahead of time if you plan on returning after the due date. Traveling is not a valid reason for paying your rent late.
Stott Property Management’s check-in and check-out procedures are fairly extensive. You must clean the property thoroughly and leave the property in the same condition that it was in when you moved in minus “normal wear and tear.” Please note that dirt and stains are not “normal wear and tear.”
The lease specifically forbids you from using the security deposit as last month’s rent. If we don’t receive the last month’s rent by the due date, then you will be charged a late fee. Stott Property Management will hire a collection agency if you fail to pay any bills and fees.
Most Property Managers run credit and background checks and will not rent to prospective tenants that owe previous landlords.
Most exchangers use 1031 exchanges to defer capital gains taxes, as the capital gains tax can be significant. However, other reasons can include:
- Leveraging dollars that would otherwise be spent on taxes
- Replacing a non-income producing property with income-producing property
- Diversifying a portfolio and minimizing risk
Basically, the value would be the sales price less closing costs.
Does a 1031 exchange defer Hawaii capital gains taxes as well as Federal capital gains taxes? What happens with HARPTA?
Yes, both Hawaii and Federal taxes are deferred. Note that the taxes are not excluded; they are deferred and could be subject to collection if you subsequently sell the new property without conducting another 1031 exchange.
HARPTA is a Hawaii law that enables Hawaii to collect (estimated) capital gains taxes from non-resident owners selling real estate in Hawaii who might not file a Hawaii income tax return. Under HARPTA, the state collects 5% of the sales price at closing with subsequent refunds if the collected amount is too high. If the non-resident owner is conducting a 1031 exchange, the withholding under HARPTA is waived.
There are two key time frames both measured from the closing date of the old property. Failure to meet either of these two time frames negates the tax-deferred 1031 exchange.
- Within 45 days, the new property must be identified in writing to the QI. You can make changes to your identification any time within the 45-day-period; however, on the 46th day, you are locked-in to whatever has been identified as new property.
- Within 180 days, the new property must close. You can identify more than one property; so if your preferred new property falls out of escrow, you could shift to a replacement new property that was identified during the 45-day-period; however, it would still have to be closed within the 180-day-period. Most exchangers identify more than one new property.
To defer all your capital gains taxes, you must buy new property that is equal to or higher in value than the old property. Again, the value would be the sales price less the closing costs. You must also reinvest all the cash proceeds from the sale into the purchase of the new property. The QI maintains the funds from the sale of the disposable property and then makes those funds available in order to enable the purchase of the new property.You cannot have access to any of the proceeds from the sale of the old property or those funds will be taxed.
You must identify a new property within 45 calendar days after the closing date of the old property. The identification is only valid if the new property has been designated as such in a written document signed by you (and any other party on title) and delivered (hand-delivered, mailed, faxed, scanned and emailed, etc.) to the QI.
There are 3 guidelines to use when selecting properties:
- 3-Property Rule: Three properties, regardless of what the fair market value is; or
- 200% Rule: Any number of properties, as long as the combined fair market value does not exceed 200% of the fair market value of all of the old properties; or
- 95% Rule: Any number of properties without regard to value, provided 95% of the value of the identified properties is acquired.
The current federal capital gains tax rate for single taxpayers with an Adjusted Gross Income (AGI) less than $400,000 and married couples filing jointly with an AGI less than $450,000 is 15% on all component of gain except depreciation recapture. Single taxpayers with an AGI greater than $400,000 or married couples with an AGI greater than $450,000 will be subject to a capital gains tax rate of 20%.
Federal Depreciation Recapture is taxed at 25%. You can find how you have depreciated the proprerty on line 18 of your Schedule E.
The Hawaii capital gains tax rate is 7.25% on all components of gain including depreciation recapture.
Single taxpayers with an AGI greater than $200,000 and married couples filing jointly with an AGI greater than $250,000 will also be subject to the 3.8% Medicare Tax.
The IRS mandates that you use a completely independent third party to supervise the exchange. Because this third party must be completely independent, it cannot be your real estate agent, accountant or attorney. The independent third party is usually referred to either as an intermediary or as a qualified intermediary (QI); however, in some areas of the country the third party may be called either a facilitator or an accommodator. This paper will use the term “QI” The QI can be located anywhere in the country; they do not need to be located near you or near either of the properties involved in the exchange.
The following steps have been changed; however, they help explain the role of the QI. The QI takes title to the old property for a brief instant in the process of having it sold from you to the buyer; i.e., title passes from you through the QI to the buyer. Similarly, the QI takes title to the new property for a brief instant in the process of having it sold from the seller to you. Therefore, the QI has owned both the old and the new properties and can exchange one for the other. Today, the QI no longer has to hold title to both properties. In 1991, the real estate industry successfully lobbied Congress to have the law changed, as escrow companies were charging double escrow fees; i.e. Seller to QI and then QI to you. Today, in lieu of taking title to both properties, the QI is tasked to provide instructions so that both transactions are closed in a manner that conforms to section 1031 of the IRC.
We can provide you guidance based on our experience working with 1031 exchanges. QI’s are not regulated either by the federal government or by most states; therefore, there may be some less-than-reputable individuals out there. This is an area where you want everything to be done correctly. The change to IRS Form 8824 requiring the exchanger to provide the name/address of their QI will enable the IRS to build a QI-client database. If they subsequently discover a QI has been abusing the rules, they will have a list of all the QI’s past clients for audit purposes.
We would only use as a QI, a company or individual that is experienced, bonded and works with exchanges on a full-time basis; i.e., we would not use an attorney as a QI who only does it on a part-time basis. If it were a relatively simple one-for-one exchange, we would probably use the exchange division of a large escrow company.
For a relatively simple one-for-one exchange of old property on Oahu to new property on the Mainland, the Oahu exchange company that many of our clients use charges about $900 plus about $250 for each replacement property. For a one-for-one exchange, a cost of about $1,150 is similar to what most QI’s charge. Some QI’s will charge a lower base fee and retain the interest earned on the exchanger’s funds (held by the QI from the close of the old property to the close of the new property). So, if you are comparing costs, ask about the interest.
If the exchange is complicated and and/or involves LLC’s, the cost is likely to be in the $3,500 and up range.
You cannot have access to any funds from the sale of the old property or those funds will be taxable. The QI places the funds (your money) into a savings account.
Note: Some QI’s retain the interest on your funds as part of their compensation. If you are shopping for a QI, this may be a cost to consider.
I understand that I cannot have access to any funds from the sale of the old property. Could I refinance the old property before I exchange it?
This is a gray area. If you were to refinance the old property in the year prior to selling it, you could have a problem with the IRS, as they might argue that your refinancing was done to circumvent the prohibition of receiving funds from the old property. On the other hand, if you could show the funds from the refinancing were used strictly for bona fide investment purposes, you might have a counter argument. You should discuss this with your attorney and QI.
Could I use funds held by the QI for costs associated with the new property like earnest money or having a feasibility study done prior to purchasing it?
The QI can only advance funds from your account for items that will be refunded if closing doesn’t occur, the most common example being earnest money. The cost for items like a feasibility study, architect fees, etc. would not be refunded if the deal fell through; therefore, the QI cannot advance funds for those purposes. However, if those costs are shown on the settlement statement at closing, they can be paid at that time with funds from your account held by the QI.
Boot is anything given or received by the exchanger that is not like-kind or does not qualify under 1031 rules. Boot can be in the form of cash, promissory note, or in the form of debt (like a mortgage). Any boot received in connection in the sale of the old property that is not offset by the boot given on obtaining the new property, is gain that must be recognized (or taxed).
- Cash paid on buying the new property offsets the cash received on the sale of the old property;
- Cash paid on buying the new property offsets debt relief on the sale of the old property; and
- Debt acquired or assumed on the new property offsets the debt relief on the sale of the old property.
Note: Debt assumed on the purchase of the new property will not offset the cash received on the sale of the old property.
Yes, however, any money that you use from the proceeds of your sale will be considered as boot and therefore will be taxed.
Both the old property and the new property must be investment real estate; in most cases they are rental properties. The two properties do not need to be the similar; e.g., you could exchange a house in Hawaii for two or more Mainland condos and vice versa. Almost any type of real estate qualifies such as a house, condo, store, office or even vacant land. Your personal residence or a second home does not qualify. However, you could rent the new property first so that it qualifies as investment property and then occupy it yourself at a later date. Many of our clients do this; i.e., they use equity in their Oahu property to assist them in purchasing a future Mainland residence.
A 1031 exchange is an exchange of investment real estate for investment real estate. It does not need to be the same kind of property nor does it have to be one for one. You can exchange commercial property for residential property or vice versa. Or, you can exchange one property for several properties or vice versa.
If I own a property that includes my personal residence and a rental unit, would it qualify for an exchange?
Yes. Consult with your CPA or tax advisor to determine the percentage value of the property you have attributed to investment. You may exchange that portion of the value.
A common misconception is you need to find someone to trade properties with you. Most 1031 exchanges involve two entirely separate transactions. In one, you sell old property and in the other, you purchase new property. There is no reason for the buyer of your old property and the seller of the new property to have any contact with each other. Often, the properties are located in two different states.
No. A 1031 exchange involves investment real estate being exchanged for other investment real estate. However, exchangers sometimes change their minds and occupy property they had intended for rental purposes. In October 2004, new federal regulations were issued as to how long an owner had to have owned a principal residence they had acquired through a 1031 exchange before they could sell it and exclude some or all the capital gain under the Tax Relief Act of 1997. Many tax experts believe this change to the federal regulations legitimized the process of conducting a 1031 exchange into new property that the exchanger rents for awhile so it qualifies as rental property and then occupies as their principal residence. You should discuss this with your Attorney and QI.
No, but you can exclude up to $250,000 of gain if you are single or $500,000 if you are married. There are other rules that may apply to this exclusion.
The Housing and Economic Recovery Act of 2008 places additional limits on the capital gains exclusion for those individuals that have either converted a primary residence into a rental or have made a previous rental property into their primary residence.
If the property has been used as a rental after 2009, then the capital gains exclusion is reduced by the following fraction:
(Number of days taxpayer rented property after 1/1/2009) divided by (Number of days taxpayer owned property)
If the sale of the home results in capital gains that exceed the allowed exclusion, then the taxpayer must report the taxable gain and pay the appropriate capital gains taxes.
This is a question to discuss with your tax advisor and QI. Obviously, the longer it is rented, the easier it is to show investment intent. In the past, there were three different opinions: (1) at least one year and a day; (2) a period of time long enough to enable two tax returns to be submitted showing it to be rental property; and (3), at least two years. Recently, there has been a decided movement towards the one-year and a day criteria.
Yes, however, the rent must be fair market rent for the property. Moreover, the rental payments must be able to be documented. Otherwise, the IRS may rule that the property is merely a second home, which would not qualify for a 1031 exchange. If you decide to rent to a related party, you should consider setting up a separate bank account with all rental payments sent there to make it easier to document that fair market rent was actually paid.
Section 1031 of the IRC states that you cannot sell to or buy from a related party unless both parties hold the properties for two years after the exchange. A related party includes your parents and grandparents, your siblings, your spouse, your children and grandchildren, and any business organizations where you or your relatives are members. The IRS has been getting increasingly tough in this area as evidenced by the need now to provide a written statement as to whether a related party was involved in the exchange.
Yes, this is commonly referred to as a construction exchange. Most exchangers want the new property to include the house rather than just the vacant land. This can create timing problems in view of the 180-day requirement to close on the new property. Therefore, a construction exchange usually necessitates considerable advance planning along with the use of a very experienced QI. Normally, a limited liability company (LLC) is established that acquires the lot, initiates contracts with the architect/builder and has the house constructed. Financing for these actions is usually provided by the exchanger outside of the exchange; i.e., not from the old property. When the new house has been completed, the lot and house are then deeded to the exchanger as the new property.
The new property must be at least as expensive as the old property (sales price less closing costs). If the new property is less expensive than the old property, the difference in value will be taxable. Sometimes the difference can continue to be withheld and used for improvements to the new property and not be taxed. Discuss this with your QI.
You must take title to the new property exactly as title was held to the old property. If the lender needs your spouse to co-sign a mortgage to the new property and be on title, your spouse must also be on title to the old property.
Note: Trusts that do not file a tax return, like a revocable living trust, are usually disregarded for 1031 exchange purposes. Therefore, the owner of a trust is treated as an individual in selling the old property and can subsequently take title to the new property in their own name. This can be very important, as many lenders will not provide mortgages to trusts. If you own the old property in a trust, this is something you should discuss with your QI and attorney.
With some very few exceptions, all of the exchanges made by our clients have been deferred exchanges where the old property is sold prior to purchasing the new property. It is possible to do this in reverse order and purchase the new property first; i.e., prior to selling the old property. This is called a reverse exchange and is more complicated and a bit more expensive than a deferred exchange. This article is based upon deferred exchanges. Over half of our deferred exchanges involved absentee owners conducting their first 1031 exchange.
Many of our first-time exchangers first look at properties in Hawaii. After reviewing the cash flow though, they often end up purchasing investment property on the mainland. The clients often choose areas they currently live in, areas they visit often, or areas they hope to retire to one day. In our experience, we suggest that you choose an Agent or company that can provide both the sale and the property management information. Ideally, the same company you purchase through will manage the property for you after the sale closes.
They use the equity they have in the old property as a down payment on the more expensive new property. For example, if you own old property worth $350,000 with a mortgage balance of $150,000, you have $200,000 of equity in the property ($350,000 less $150,000). Using a 20% down payment, the $200,000 should enable you to buy a new property for $1 million. The rent that you expect to receive from the new property would be used to help you qualify for a mortgage on the new property.
I own one-half of a property with my brother owning the other half with title being in both of our names. He wants to cash his half out while I want to conduct a 1031 exchange with my half. Is this possible?
As a general rule, yes; however, this is something you need to discuss with your QI. And, you would need to take title to your new property exactly as you held title to your half-interest in the old property.
No. The IRS has ruled that REIT shares do not qualify as real estate in an exchange. A REIT is like a mutual fund that owns real estate; it is a security, not real estate. There is an exception for a special type of REIT called an UPREIT or Umbrella Partnership REIT but there are restrictions; e.g., you can’t exchange out of an UPREIT to buy actual real estate.
Yes. A leasehold property must have at least 30 years remaining until the expiration of the lease (the expiration date, not the renegotiation date).Many leasehold properties on Oahu no longer qualify, as their leases are now too short; the list of such properties grows each year.
IRS Form 8824 is a 2-page form that must be submitted in the year that you sold your old property.
- You will be required to state on the form whether your 1031 dealings were with a related party.
- You will be required to include the name/address of the QI.
Three relatively recent rules apply to principal residences. The tax relief act of 1997 enabled a homeowner to sell their principal residence and exclude up to $500,000 of gain (married) or up to $250,000 (single) providing they had occupied the home for an aggregate 24 out of the prior 60 months. So an owner only needed to own the property for three years, one year as a rental to qualify for the exchange and then two years as a principal residence to qualify for the tax relief act of 1997. In October 2004, there was a change to the 1997 law. An owner who acquired their principal residence by way of a 1031 exchange must now own the property for at least five years before they sell it in order to be eligible for the exclusion. The owner still needs to rent it for enough years so it qualifies for the exchange and then have it be their principal residence for at least two years. The exchanger also has to pay depreciation recapture on depreciation claimed (after May 6, 1997) while the property was a rental; i.e., depreciation recapture while the property was a rental will not be excluded.
The Housing and Economic Act of 2008 reduces the capital gains that can be excluded when a homeowner sells a principal residence that they acquired via a 1031 exchange, as the amount of the tax exclusion will be adjusted by the non-resident use of the property. This law became effective 1/1/09. The amount of time of non-resident use after 1/1/09 is the numerator or top of a fraction with the bottom or denominator of the fraction being the total time since property acquisition. That fraction times total gain (exclusive of depreciation recapture after May 6, 1997) is the gain that will be taxed to the homeowner.
Example: Single Mary bought her Oahu home on 1/1/93 for $200,000 and rents it for 18 years until 1/1/11 when she occupies it as her primary residence. Two years later, on 1/1/13, Mary sells the property for $500,000 and has $300,000 of gain.
The non-residence use of the property by Mary prior to 1/1/09 does not apply to the new law. Therefore, Mary has only two years of non-residence use that applies from 1/1/09 to 1/1/11 when she then occupies it as her primary residence for two years. Mary will have owned it for a total of 20 years. Therefore, the fraction for non-resident use is 2/20. Or, the taxable gain is $300,000 x 1/10 or $30,000. The remaining $270,000 exceeds the $250,000 limit for single Mary, so Mary ends up with $50,000 taxable ($30,000 + $20,000) and $250,000 that is excluded. Mary would also owe depreciation recapture after May 6, 1997 that is taxed at 25%.
In our example, we used a long period of ownership before the eligibility date. If the property were acquired after the 1/1/09 eligibility date, the fraction will be much larger. For example, assume the property is acquired on 1/1/09, rented for three years and then occupied for two years, the non-resident use would be 3/5 or 60%. However, if it is rented for only one year and then occupied for four years, the non-resident use would only be 1/5 or 20%. Every day it is a rental property after 1/1/09 increases the capital gains taxes to the owner.
Granted, the new law has no impact if the owner never sells the property; however, few homes remain suitable for the same family over any extended period of time. Over time, most families desire a different location and/or a larger/smaller/more prestigious or a completely different type or style of home particularly after they retire or become empty nesters.
There are four ways to conduct an exchange. The first is to conduct a deferred or delayed exchange as discussed in this paper.
The other three are as follows:
- The Reverse Exchange: This occurs when the new property is acquired prior to the sale of the old property.
- The Simultaneous Exchange: This occurs when the old property and the new property both close at the same time.
- The Improvement Exchange: This occurs when you wish to use proceeds from the exchange to make capital improvements to the new property.
HARPTA is an acronym for the Hawaii Real Property Tax Law. HARPTA is a law, not a tax, a common misunderstanding. The Hawaii law is similar to laws passed by other states (e.g., California) as well as a federal law that applies to non-U.S. citizens. Under HARPTA, an estimate of an owner’s capital gains tax that will be due Hawaii is withheld at closing. Prior to the passage of HARPTA, the state had no means of collecting such taxes unless the absentee owner filed a Hawaii income tax return for the year of the sale.
NOTE: Some absentee owners may be exempt from the HARPTA law. However, the fact that an owner may be exempt from the HARPTA law does not also exempt the owner from paying state capital gains taxes that may be due Hawaii.
The amount collected under the HARPTA law is 5% of the sales price. Hawaii has determined that 5% of the sales price provides a reasonable approximation of the capital gains tax that may be due the state.
If the 5% of sales price withholding is too large, the owner files a Hawaii form N288C after closing. Refunds normally take 4-6 weeks except during the tax season. Hawaii has no provision for filing a form prior to closing so the correct amount will be withheld.
What if there are insufficient proceeds from the sale to pay the withholding or if there is a loss on the sale rather than a gain?
The withholding may not be required if there are insufficient proceeds from the sale or if there has been a capital loss rather than a capital gain. When either of these occurs, escrow will not close the transaction until a Hawaii form N288B has been approved by the state (unless the seller agrees to pay the withholding). If the sale creates a capital loss or the proceeds available are insufficient, the owner must submit appropriate paperwork to the state. This paperwork must include (as applicable): (a) a copy of the closing statement when the property was purchased; (b) documentation showing depreciation that has been claimed; (c) documentation for any capital improvements; (d) documentation for deferred gain from any prior sale(s) that adjusted the owner’s buying basis; and (e), an estimated closing statement prepared by escrow.
NOTE: To allow time for approval, the N288B form must be submitted to the state at least ten days prior to closing. Since an estimated closing statement prepared by escrow has to accompany the N288B form, it is usually submitted relatively late during the escrow process. If the N288B form is rejected by the state, there is usually insufficient time to submit a revised form and still meet the scheduled closing date.
NOTE: Most absentee owners should have a CPA or professional tax advisor prepare their N288B form to document a capital loss. It is relatively common for the state to reject applications because of insufficient documentation. We have had absentee owners agree to pay the withholding when there was no gain merely to be able to close their transactions as scheduled. The owners were reimbursed after the sale: however, they could have avoided any withholding had they submitted a better package.
NOTE: The state may adjust the withholding to a lesser amount if there is a gain but insufficient proceeds available to pay 5% of the sales price.
NOTE: The N288B form has a section where the owner indicates if the property has been a rental and if so, the owner’s Hawaii General Excise Tax (GET) number for the property. If you have not been paying Hawaii GET on your rental receipts, you may have to pay past GET plus a penalty/interest in order to have a N288B form be approved.
Is Hawaii tax law for the sale of a personal residence similar to the federal law; i.e., the Taxpayer Relief Act of 1997?
Yes. This federal law allows an owner to exclude up to $250,000 of gain (single) or up to $500,000 of gain (married) providing they have owned and occupied a property for at least two out of the past five years. Lower exclusions may be allowed under certain circumstances if the owner occupancy time frame has been less than two years. A N289 form must be completed if this law applies.
The forms can for obtained from the state. Select “Forms” rom Hawaii.gov/tax and go to the “Alphabetical List”. Select “N” and scroll to the applicable form. The forms can be downloaded from the state website here.
A nonresident owner for purposes of HARPTA is an owner who does not file a Hawaii resident tax return.
Military members are exempt from the withholding at closing if the sale involves their primary residence and they are being transferred from Hawaii under military orders and a N289 form has been completed. For purposes of HARPTA, a military member is defined as someone on active duty when their Hawaii property closes.
The 2003 Military Family Tax Relief Act (MFTRA) may apply. A taxpayer on qualified extended duty in the U.S. Armed Services or the Foreign Service may suspend for up to 10 years of such duty time the running of the 5-year ownership-and-use period before the sale of a residence. Please consult with your tax advisor. An approved N288B form from the state is required to have the HARPTA not collected at closing, if the MFTRA applies. If HARPTA is collected, and the MFTRA applies, the owner can apply for a refund after closing.
Following are the most common exceptions:
a. There is no taxable gain on the sale and an approved N288B form has been received from the state.
b. There are insufficient proceeds from the sale to pay the withholding and an approved N288B form has been received from the state. If some proceeds are available and there has been gain, the state may adjust the withholding to a lesser amount.
c. The capital gains tax due on the sale of a personal residence has been excluded by having owned and occupied the property for two out of the past five years and a N289 form has been completed.
d. In the year prior to the sale the property was used as a primary residence and the sales price is $300,000 or less and the seller has completed a N289 form.
e. The owner is in the military and selling their primary residence and has completed an N289 form.
f. The owner conducts an IRC 1031 tax-deferred exchange.
No taxable gain applies when there is a loss on the sale rather than a gain. No taxable gain may also involve transfers of property incident to a divorce, as a gift, or as an inheritance.
HARPTA has the buyer responsible for paying the withholding if appropriate documentation is not provided by the seller. Therefore, escrow will automatically withhold 5% of the sales price unless the seller can document that no such withholding is required.
Many owners mistakenly use these terms interchangeably. They are completely different.
Gain is the total profit received following the sale of a property. It establishes the basis for both federal and state capital gains taxes. Equity is the value remaining in a property after paying off the mortgage and any other liens. Equity is the amount of money you will receive from the sale before paying the costs to sell.
Refinancing a home impacts upon equity and what you’ll net out of a sale, however, it has nothing to do with gain. Your gain on any specific property is the same regardless of whether you own the property free and clear or have a sizable mortgage. Assume you own a property without a mortgage. If you were to sell the property for $400,000 (equity of $400,000) and your closing costs were $30,000, you would net $370,000. If you had financed the property after purchasing it and had a mortgage balance of $300,000 (equity of $400,000 less $300,000 or $100,000), you would net $100,000 in equity less the $30,000 in closing costs or $70,000. However, your gain in either case would be the same; i.e., whether you have equity of $400,000 or $100,000 or net $370,000 or $70,000, your capital gains taxes would be the same.
Gain is determined largely by appreciation, how much more valuable a property is when you sell it compared to the price you paid when you bought the property. Other factors in determining gain are: (a) capital improvements you have made while owning the property including purchasing the fee; (b) depreciation you have claimed while owning the property; and (c), any deferred gain you may have had from a prior sale that was rolled over into the property when you bought it.
The law itself is short and basic; however, interpretations can be very complex, particularly for individuals who travel frequently making their residency questionable. The Income Tax Specialists at the Technical Section provide free assistance to the public. We have found them to be very cooperative and generous with their time.
They can be reached at: Technical Section
P.O. Box 259
Honolulu, HI 96809
Phone : The toll-free number is: (808)-587-1577
The toll-free number is frequently busy. Some of our clients have found it easier to call long distance using the local number.
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