Will You be subjected to a hefty withholding?
Buying real estate in Hawaii is complicated enough that even kama’aina will want to work with a capable real estate agent and line up a great lender, escrow company, home inspector and others (all people your agent can help you with). It is even more critical for out-of-state and foreign Buyers and Sellers to be familiar with the Hawaii Real Property Tax Act (HARPTA) and Foreign Investment in Real Property Tax Act (FIRPTA).
One thing Sellers need to know when they sell Hawaii property, is that where you live makes a BIG difference. You could be subject to tax withholdings if you are not residing in the state of Hawaii at the time of the sale.
HARPTA (Hawaii Real Property Tax Act) requires withholding 7.25% of the sales price if you don’t live in Hawaii when you sell.
A seller is exempt from HARPTA when the seller can certify that he/she is:
1. a Hawaii resident person or entity (includes resident aliens), and
2. a Hawaii taxpayer, with the seller’s home address and taxpayer ID number.
There’s a few other Exceptions to the HARPTA Withholding Requirement:
1. If the seller does not realize a gain or loss with the sale, e.g. 1031 exchange. Or,
2. If the property was used as the seller’s principal residence for the year before the sale and the sales price is $300K or less. Or,
3. If the seller is an out-of-state corporation registered to do business in Hawaii and current on HI tax payments.
Immediately after opening escrow, the seller may also submit to the tax office the application Form N-288B for a ‘waiver’ or ‘adjustment’ of withholding:
If the seller can prove that he or she will not realize any gain from the sale. Or,
That there will be insufficient proceeds to pay the withholding required.
The tax office may take up to 10-business days to process and approve the N-288B application. If the tax office approval is not obtained before closing, then escrow must send the withholding to the tax office.
For the Seller’s Refund of HARPTA Withholding:
After the closing date, the seller may file:
Form N-288C for a tentative refund of withholding, but only if Form N-15 is not yet available.
Form N-15 annual state tax return when available. Even if the seller already filed Form N-288C, the seller must file Form N-15 for the tax year reconciliation.
Most HI tax refunds take 4-8 weeks and a few take as long as 16 weeks.
FIRPTA (Foreign Investment in Real Property Tax Act) requires a withholding of 15% of the sales price when you don’t live in the USA, in addition to the HARPTA withholding.
The seller is exempt from the FIRPTA withholding when the seller certifies that he/she is:
1. a US resident person or entity (includes resident aliens), and
2. a US taxpayer, with the seller’s home address and taxpayer ID number.
Other Exceptions to the FIRPTA Withholding Requirement:
1. If the seller is an out-of-the-country corporation registered to do business in the US and current on US tax payments. Per sec. 897(i), the certification must include a copy of the IRS’s acknowledgment of the election received. Or,
2. If the buyer intends to occupy the property as their principal residence for the next 2 years after the closing date, the required FIRPTA withholding is reduced as follows:
a.) 10% of the sales price for properties sold between $300,001 to $1Mill.
b.) 0% of the sales price for properties sold up to $300,000.
Immediately after opening escrow, the seller may also file IRS Form 8288-B and apply for a withholding certificate. The seller must notify the buyer in writing that the certificate has been applied for before the closing date. The IRS approval may grant a ‘waiver’ or ‘adjustment’ of withholding, when:
The seller is exempt from U.S. tax, or nonrecognition treatment applies.
The seller’s maximum tax liability is less than the tax required to be withheld.
The seller sells under special installment sales rules. (Sec. 7 of Rev. Proc. 2000-35 allow for reduced withholding)
There will be insufficient proceeds to pay the withholding required.
The seller enters into an agreement with the IRS for the payment of the tax.
The IRS response ‘withholding certificate’ or a ‘denial letter’ often take within 90 days from submitting the 8288-B application. Sometimes the IRS takes as long as 6 months.
A withholding certificate issued before the closing date means reduced withholding or no withholding is required. A denial letter before the closing date means withholding must be paid to the IRS within 20 days after the closing date.
If the application Form 8288-B was submitted to the IRS before the closing date, but there is no IRS response by the closing date, then escrow should temporarily withhold and wait for the IRS response before making the payment. Once the IRS issues the certificate or the denial letter, then the appropriate withholding must be paid to the IRS within 20 days after the IRS response date.
When a FIRPTA withholding is required, the buyer completes Form 8288, together with 8288–A for each seller from whom the tax has been withheld. Escrow mails to the tax office the withholding with the completed Form 8288 and copies A and B of Form 8288–A. The Buyer keeps Copy C for their records. The IRS will mail a stamped copy B of Form 8288-A to the seller.
Seller’s Refund of FIRPTA Withholding:
After the payment of the withholding to the IRS, the seller may file:
For a tentative early refund, if the withheld amount exceeds the maximum tax liability, but only if the U.S. income tax return (e.g. Form 1040NR or 1120-F) is not yet available. The seller must first get a withholding certificate before applying for an early refund. There is no particular form, except the early refund application must include the following in separate numbered paragraphs:
1. Seller’s name, address, and U.S taxpayer ID number;
2. The amount to be withheld as per the IRS’s withholding certificate;
3. The amount withheld (box 2 of Form 8288-A, a copy must be attached);
4. The amount to be refunded.
The seller must mail the application for the withholding certificate and/or for an early refund to: Ogden Service Center, PO Box 409101, Ogden, UT 84409
U.S. income tax return Form 1040NR or 1120-F when available and attach the stamped Form 8288-A to receive credit for any tax withheld. Even if the seller already filed for an early refund, the seller must file 1040NR or 1120-F for the tax year reconciliation.
Most federal tax refunds take about 90 days. Some take up to 6 months.
Keep Records For 5 Years
If the seller only recently moved away within less than 180 days of the sale, then the seller may still be considered a resident person and be exempt from the withholding.
The buyer may rely on the seller’s certification of the ‘nonforeign status’ for FIRPTA, and the ‘Hawaii resident status‘ for HARPTA. However, if you are the buyer and you know that the certification is false, then you could be on the hook to pay the withholding! Keep the seller’s certification on file for at least 5 years from the date of sale. It should be part of your closing paperwork packet.
The IRS requires the buyer’s tax ID number on Form 8288 at the time of purchase. Foreign buyers without an existing tax ID number must apply for an ITIN (International Tax ID Number). Some passport notarization services and local CPA companies that are qualified as a CAA (Certified Acceptance Agent) can notarize the foreign buyer’s passport and help obtain an ITIN for the buyer.
As long as the foreign buyer does not generate income in the US, the buyer is not required to file annual tax returns. That is until the buyer sells the property.
Why Does Hawaii have FIRPTA/HARPTA?
The state of Hawaii and the federal government had been missing out for years when out-of-state and out-of-country owners sold Hawaii properties and failed to pay capital gains taxes. As a result, HARPTA and FIRPTA tax laws were established to prevent this loss of tax revenue.
The tax withholding laws don’t replace or increase the actual capital gains tax that are due. They do withhold a sufficient amount larger than the actual tax due to prevent the seller from evading this tax.
Technically, it’s the buyer’s responsibility to make sure the seller’s withholdings are mailed to the tax office. But in reality, the escrow company withholds from the seller’s proceeds and sends the funds to the tax office. This is per the terms P-1 and P-2 of the standard Hawaii Real Estate Purchase Contract.
The IRS Claims That The Withholding Is Delinquent!
Imagine weeks after you closed on your purchase, you get a letter from the IRS or the Hawaii tax office claiming that you owe big bucks because the required withholding hasn’t been received!?
You will need to call your escrow company and request a copy of the cashed check as proof that the withholding was indeed mailed and cashed by the IRS or the Hawaii tax office. Mail the evidence to the requesting tax office.
Who can help with this?
At www.Harpta.com you’ll find a company that specializes in assisting home sellers obtain a HARPTA/FIRPTA waiver, reduction or an early refund of their withholding.
“We have more experience with HARPTA and FIRPTA than any other tax professional in the state. Our clients typically receive refunds in the tens of thousands of dollars” according to their website.
Note: The above is for information purposes only, it is NOT intended as legal, financial or tax advise - for that, please consult licensed and reputable advisors in said sectors.