Special Tax Considerations for Foreigners & Non-Residents of Hawaii
The Federal government requires withholding 10% of the gross proceeds any time a foreign seller conveys property. Escrow will also withhold an additional 5% if the foreigner is not a Hawaii resident. Foreigners or out-of-state owners who make even a penny on the sale of real property are subject to withholding. Buyer and seller alike should be aware of nuances and recent changes pertaining to the Foreign Investor Real Property Tax Act (FIRPTA) and the Hawaii Investor Real Property Tax Act (HARPTA).
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Buyers are notified of residency status by way of a signed affidavit not long after escrow is opened. Buyers aren’t required to investigate a seller’s claim, but they should retain a copy of the declaration because a buyer could be held responsible for any tax related to the sale if seller fails to pay!
Who is Not Subject to FIRPTA and HARPTA?
Sellers able to show a loss may apply for a withholding waiver. This should be done well in advance; however, in today’s market, sellers with no gain or those with a loss should be a red flag to the REALTORS® involved. Nonetheless, a HARPTA exemption request should be received by the state at least 10 days prior to the scheduled closing date.
In the past, the state basically compared purchase and sale settlement statements when determining exemption eligibility. Recent procedures require that sellers not only submit closing statements and expense reports, but copies of all tax returns related to their ownership period.
Sellers must present a state tax return for any income-producing years and they must be current on all General Excise Tax (GET) payments. An ownership change, especially adding an owner to the deed, could trigger HARPTA withholding for at least the added owner. A last minute change to avoid withholding is probably not okay.
Sellers subject to FIRPTA (Foreign sellers) should allow 6 weeks for approval of a withholding exemption. The withholdings can be likened to payment of estimated tax payments. Any refund is based on a seller’s entire tax picture. No exemption will likely be granted until GET payments are made, federal and state tax returns are filed, and all tax payments are current. A buyer with an out-of-state seller is wise to ask if an exemption will be filed. Failure to address the issue could delay closing, causing loan issues.
The state of Hawaii extends residency courtesy for one year following the date the resident relocates outside the state. The assumption is that sellers leaving Hawaii need to file at least one more residency return. Sellers participating in a 1031 exchange are not subject to HARPTA/FIRPTA withholding because they are deferring gain. Seller-financed sales may be subject to either incremental withholding or lump sum withholding if legal title passes.
It’s important to consider how the HARPTA/FIRPTA withholding will impact the required down payment on any seller-financed contract. Resident aliens are regarded as residents for the purposes of withholding.
Do Yourself a Favor
If a move is in your future, be sure your agent checks current seller residency early on. Trust me, these tax issues are a last minute surprise nobody needs, and as we all know, when it comes to real estate sales, surprises are rarely a good thing!