Understanding HARPTA and FIRPTA on Maui and Hawaii
Maui real estate is among the most robust long-term equity growth markets in North America. It’s no surprise, then, that it attracts investors from around the country and the world. Indeed, nearly one-third of real estate across Hawaii is owned by non-residents – and this presents challenges for the state and federal government when collecting applicable taxes.
Real estate transactions in Hawaii are subject to a variety of state and federal taxes. If the seller has been receiving rental income, General Excise Tax, GET, applies. If short-term rental income has been collected, a situation in which tenants occupy the premises for 180 days or fewer, Transient Accommodation Tax, TAT, applies. Finally, taxes for any capital gains realized through the sale must also be paid whenever investment properties are sold. Learn more about investing in these units with our short-term rental buyers guide for Maui.
As property investment among non-Hawaii residents soared in popularity, the state began struggling to collect applicable taxes from those sellers. The state government enacted the Hawaii Real Property Tax Act, HARPTA, to combat this during the 1990s. What is HARPTA withholding? Under current HARPTA regulations, a withholding of 7.25% on the amount realized – typically the sales price – must be collected when non-Hawaii residents sell real estate anywhere in the state.
What is HARPTA & FIRPTA?
If you’re a non-U.S. resident who has invested in real estate in this country, you’re already familiar with the Foreign Investment in Real Property Tax Act. Commonly referred to as FIRPTA, it was enacted in 1980. FIRPTA ensures that the federal government can collect applicable taxes from non-U.S. property owners generated through real estate transactions.
Like HARPTA, FIRPTA requires the withholding of funds to ensure that applicable taxes are collected. Currently, FIRPTA requires a 15% withholding on the amount realized through real estate sales transactions, and HARPTA was closely modeled after FIRPTA. If you are a non-U.S. resident selling an investment property in Hawaii, HARPTA and FIRPTA withholdings both apply.
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Who Has to Pay HARPTA?
In Hawaii and on Maui, real estate buyers are contractually obligated to collect and remit HARPTA withholdings when dealing with out-of-state sellers. In many cases, HARPTA withholdings are collected and remitted by escrow companies as part of the usual sales transaction process.
So, who has to pay HARPTA? Put simply, any non-Hawaii resident selling real property in the state must do so. Therefore, U.S. residents and foreign nationals alike are subject to HARPTA withholdings. Like any tax law, however, there are exceptions. By understanding these exceptions, you may be able to avoid having 7.25% of the proceeds of your real estate sale tied up following such transactions.
HARPTA and FIPTA are Not Taxes
Contrary to popular belief, HARPTA and FIPTA are not actually taxes themselves. Rather, they are withholdings made to ensure that any applicable taxes from such sales are collected in a timely and effective manner. Think of it like the tax withholdings made on a regular paycheck, wherein the government collects estimated taxes every pay period. After official calculations are made at tax time, refunds on these withholdings are often given; the same is often true regarding HARPTA and FIPTA withholdings.
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It’s Easy to Overpay Due to HARPTA
The 7.25% withheld via HARPTA reflects the 7.25% capital gains tax that applies in the state of Hawaii. However, the vast majority of the time, the withholding far exceeds the amount of the seller’s actual tax liability. If no tax liability exists at the time of sale – in other words, if all applicable taxes, including GET and TAT, have been paid – a refund is usually owed.
This refund may “come out of the wash” at tax time when the seller files a non-resident state income tax return, Form N-15. Alternatively, it may be provided more quickly through the filing of Form N-288C, Application for Tentative Refund.
How HARPTA Works: A Simple Example
Because of HARPTA, if you sell a condo in Hawaii for a sales price of $1 million, 7.25% of the sales price -- $72,500 – is withheld at the time of sale. Let’s say you purchased the condo in 2010 for $600,000 and invested $200,000 in remodeling and improving it.
Your total “basis” would be $800,000. If you sell it for $1 million in 2021, your total capital gains would be $200,000. At the applicable capital gains tax rate of 7.25%, you would owe $14,500. Since HARPTA requires 7.25% of the sales price to be withheld, you essentially “overpay” by $58,000, and that money is tied up until a refund is given. If you wait until filing your annual state tax return, you could be out the money for a long time.
How Do I Avoid HARPTA Taxes?
Property investors dislike having so much of their profits tied up due to HARPTA withholding requirements. Fortunately, there are a few ways to avoid them – or, at the very least, to get the money you’ve overpaid back more quickly:
- N-289 Exemption – You may qualify for an exemption from HARPTA withholdings by filing Form N-289 before selling your property. Qualifying examples include being a resident of Hawaii; situations where the gains on the sale aren’t taxable under the federal Internal Revenue Code, IRC, as adopted by Hawaii; the amount realized by the sale is less than $300,000 or the property was the seller’s principal residence in the year preceding the sale.
- N-288C Refund of Withholding – Instead of having to wait until tax season, you may be able to file Form N-288C to receive a refund within four to six weeks. Unfortunately, there is no provision for filing this form prior to closing to ensure the proper amount is withheld.
- N-15 Non-Resident Hawaii State Income Tax Return – At tax time, April of every year, file Form N-15 to obtain a full or partial refund of HARPTA withholdings.
- 1031 Exchange – Withholdings, including HARPTA, are not applicable for investors effectively carrying a 1031 Exchange. Section 1031 of the IRC permits the deferment of capital gains taxes realized on the sale of investment real estate when exchanged for other investment real estate, which must be purchased within a specific timeframe.
FIRPTA and HARPTA: A Double Whammy
If you’re a U.S. resident but not a resident of Hawaii, you only have to worry about HARPTA withholdings. However, if you’re a non-U.S. resident, HARPTA and FIRPTA withholdings apply. This is particularly true for Canadians who own real estate on Maui as they make up the largest non-US ownership group. As with HARPTA, FIRTPA requires the withholding of estimated taxes, which may be refunded later.
Whether you’re subject to HARPTA withholdings, FIRPTA withholdings, or both, you have options. In most cases, 1031 exchanges are among the best ways to manage the worst aspects of these tax laws. If you’re interested in investing in real estate in Maui, it pays to consult a skilled tax professional who specializes in property investments and related matters. Please reach out to me anytime even if you just need a referral for an intermediary, advice on real estate matters, or are considering selling your property.
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