Capital gains tax is a tax that you need to pay when you sell an asset that has gone up in value. This includes things like real property, personal use items like household furnishings, and stocks or bonds held as investments. For real property, a person is taxed on the difference between what they bought the asset for plus any improvements (called “basis“) and the net sale price. In order to ensure payment of this tax when there is a transfer of real property, there are laws which were put in place that require a withholding of sales proceeds by the purchaser. Though the responsibility of the withholding falls to the purchaser, when an escrow company is involved in the transaction, they typically provide the necessary forms to report the withholding.
Under the Hawaii Real Property Tax Act, (HARPTA), Hawaii residents and non-residents alike must pay capital gains tax realized on the sale of real property unless the gain can be excluded under Hawaii income tax law. Many non-residents don’t realize that they are subject to Hawaii taxation and don’t file a Hawaii income tax return or pay the tax due when they sell a property.
HARPTA legislation requires a purchaser to withhold a percentage of the sales price when acquiring Hawaii real property from a nonresident seller and remit the amount withheld directly to the State. Currently, a purchaser must withhold 7.25% of the gross sales price. The withholding amount was 5% for dispositions prior to 9/15/18.
In addition to HARPTA, non-US citizens must pay an additional 15% (effective 2/19/16) of the gross sales price under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). The rate was 10% for dispositions before 2/17/16. So as a foreign investor, they are subject to a possible 22.25% withholding.
A seller may apply for an exemption within 10 days prior to the close of the transaction, if the seller will not recognize any gain on the sale or if there will be insufficient proceeds to pay the required withholding after paying costs such as selling costs and the amount of any mortgage or lien secured by the property. The amount withheld is an estimated income tax payment and is claimed on the Hawaii income tax return that the seller must file for the year of sale. Any overpayment of tax is refunded after the return is processed.
Click on this link to a State of Hawaii webpage to find forms that you can fill out to request an exemption from withholding taxes, to file a withholding, or to request the balance of your withholding.
There is good news for Hawaii residents. A single person is exempt from capital gains tax with a gain of up to $250,000 on the sale of their home, and married couple with a gain of up to $500,000 if they 1) owned the home for at least 2 years and 2) lived in the home as a primary residence for at least 2 of the past 5 years. There are also strategies to defer paying capital gains tax by participating in a 1031 tax deferred exchange or a monetized installment sale.
For more information on capital gains tax, please consult a lawyer or tax professional. The information provided in this article does not provide tax or legal advice.