The Hawaii Real Property Tax Act, HRS 235-68, (HARPTA), is a state law requiring buyers who purchase Hawaii real estate from a non-resident person to withhold 7.25% of the gross sales price and remit it directly to the Hawaii Department of Taxation at closing. This is not a new tax, but a pre-payment mechanism designed to ensure the State collects capital gains tax owed by the non-resident seller(s) on the transaction.
This withholding can be substantial, even if the net proceeds distributable to the sellers are not, because it is based upon the gross proceeds rather than the net. It is required only when a seller is not a Hawaii resident. In those cases, the withholding is mandatory unless the seller qualifies for and obtains an exemption or withholding certificate from the Hawaii Department of Taxation prior to closing.
When applicable, HARPTA directly affects the net cash each party receives at closing.
For Example:
• Gross Sales Price: $1,000,000
• One Spouse is a non-resident, HARPTA applies
• Divorce Decree: Proceeds to be split 50/50 after mortgage payoff and closing costs.
• HARPTA Withholding (7.25%): $ 36,250.00
Without HARPTA Planning:
• Total net proceeds (after mortgage, commissions, etc.) might be $300,000.
• The escrow company is legally required to remit $36,250 from the non-resident seller’s share to the State, leaving the resident seller with $150,000, and the non-resident seller with $113,750.
• The $36,250 is held by the State as a credit toward the non-resident seller’s final income tax liability. Any refund will issue only after the annual Hawaii tax return (N-11 or N-15) is filed.
Solutions and Strategies:
To avoid this cash flow shortfall, proactive steps can can be taken:
• Secure a HARPTA Exemption Certificate: If the sale will result in no taxable gain, an exemption can be applied for. Common grounds in a divorce include:
• The sale price is less than the original purchase price (an actual loss).
• The property qualifies as the “principal residence” and meets the IRS Section 121 exclusion criteria (owned and used as a primary home for 2 of the last 5 years), which Hawaii generally follows. This can often shield up to $500,000 of gain for a married couple filing jointly.
or
• Apply for a Reduced Withholding Certificate: If there is a gain, but it is less than the 7.25% gross withholding amount, the seller(s) can apply for a reduction based on their estimated actual tax liability. This is common when there is a large mortgage being paid off, significantly reducing the taxable gain.
or
• If an exemption or reduction is not secured in time, the spouses can agree to an immediate distribution of funds and a further distribution once the tax refund is obtained to ensure that one party is not unfairly burdened by the temporary loss of the withheld funds. Of course, the resident seller may also owe taxes on the sale, and those forecasted taxes should be considered in deciding upon the distribution(s).
Counsel for both parties should address HARPTA early in the divorce negotiations and real estate sales process. The optimal path is to engage a qualified tax professional or attorney to prepare and file the necessary HARPTA exemption or reduction application with the Hawaii Department of Taxation as soon as the property goes into escrow. However, there is no guarantee that the Department will process the application in time so it is also prudent to address that contingency when agreeing upon the initial distribution of proceeds.
Failure to plan for this requirement will result in delayed access to a significant portion of the sale proceeds, creating unnecessary financial strain for one or both individuals.
