Hawaii Increases Withholding Rate on Sales of Real Property by Nonresidents

The state of Hawaii has enacted legislation that changes the withholding rate on real estate sales by nonresidents from 5% to 7.5%, effective for transfers on or after 15 September 2018.

Like a number of other U.S. states, Hawaii law requires buyers or transferees of Hawaii real property from nonresidents to withhold and remit a tax, which is designed to make sure the nonresident seller reports and pays any income tax due on the sale. The withholding rate has been 5% since the law was enacted in 1991. It is not clear what prompted the legislature to increase it to 7.5%.

The law exempts sellers where the real property has been used as the seller’s principal residence for the year preceding the date of the contract, and the contract price does not exceed $300,000, or the seller is not required to recognize any gain under a non-recognition provision of the Internal Revenue Code. Tax Information Release No. 2002-2 (May 8, 2002) explains that the latter includes section 121 of the Internal Revenue Code, which has been adopted by Hawaii. 

Consequently, if gain is not taxable because a property was the principal residence for qualifying periods and the other requirements of section 121 are met, no withholding is required.

Corporations are exempt if they are chartered or domesticated in Hawaii; domesticated partnerships are also exempt. Generally, this means that corporations registered to do business in Hawaii are exempt. Hawaii defines an individual as a "resident" in a detailed manner and the "resident" exemption needs to be determined in light of these definitions. TIR 2002-2 says that residency status is determined at the time the sale closes. 

Exemptions are certified on Form N-289, which does not require Hawaii Department of Taxation approval. If there is no gain on the sale, the seller may obtain a waiver from the Department of Taxation by filing Form N-288B at least 10 days before the date of transfer. 

Related: U.S. IRS Reiterates Position Limiting Deduction of Pre-Paid 2018 Property Taxes

How This Impacts Mobility 

In those limited instances in which the Hawaii withholding tax applies to a relocation transaction, Worldwide ERC® members must be careful to withhold the correct (higher) amount. There are substantial penalties for inadequate withholding. 

In a typical relocation transaction, two separate transfers of the employee's property occur: The first is the transfer from the employee to the corporate employer or relocation management company, and the second is the transfer to an independent third-party buyer. The employee usually will be exempt from withholding due to the exemption for sales of the principal residence, or because the employee was still a resident at the time of sale. Consequently, the only impact on the first sale in a relocation transaction generally is that the employer or relocation management company has to be careful to create or obtain the necessary paperwork to support whatever exemption is being claimed. 

The subsequent sale by the corporation or relocation management company generally will also be subject to withholding if the company is not a resident of the state, unless the company takes advantage of other means of avoiding it. As noted, Hawaii allows the seller to avoid withholding if it can demonstrate that there is no gain on the sale.

However, depending on when the sale occurs, and the employee’s residency status at that time, there may be instances when the withholding applies.

Read More