Hawaii HARPTA and Form N-289 for a 1031 Exchange

HARPTA withholds 7.25% of the price, not the gain, and applies to residents too

HRS section 235-68 directs every transferee to deduct and withhold 7.25% of the amount realized on the disposition of Hawaii real property, and makes the person required to withhold liable for the tax. The Department's Tax Facts 2010-1 stresses a common misunderstanding: HARPTA applies to Hawaii residents as well, and the buyer must withhold unless the seller gives Form N-289 certifying residence.

The amount realized is generally the sales price, but it includes the fair market value of property received and any liability the buyer assumes or takes the property subject to. A $1,500,000 non-recourse mortgage taken over by the buyer is part of the base.

HARPTA is not a tax. The Department describes the withholding as an estimated tax payment made for the seller, credited when the seller files the Hawaii return for the year of sale. The buyer reports and pays on Forms N-288 and N-288A within 20 days after the transfer date, which is the day title passes.

Form N-289 box 2 is the exchange certification, given to the buyer and not to the state

Form N-289 has three boxes. Box 1 certifies that the seller is a resident person under section 235-68, which for entities includes an LLC formed or registered under Chapter 428 and treats a disregarded single-member LLC's owner as the seller. Box 3 covers a principal residence sold for $300,000 or less. Box 2 certifies that, by reason of a nonrecognition provision of the Internal Revenue Code as operative in Hawaii, the seller is not required to recognize any gain or loss.

Box 2 requires two written items: A, a brief description of the transfer, and B, a brief summary of the law and facts supporting nonrecognition. For an exchange that usually means identifying the qualified intermediary arrangement and citing section 1031. Tax Facts lists the section 1031 exchange as the most common nonrecognition provision and notes the replacement property does not need to be in Hawaii.

The seller signs under penalty of law and gives the form to the buyer; it is not filed with the Department for approval. If all sellers provide one, the buyer keeps it. If only some do, the buyer attaches copies to the N-288 and N-288A it files for the others. The statute removes the protection if the buyer actually knows the certification is false.

Any boot means the full 7.25% is withheld

The statute exempts a transfer only when the seller is not required to recognize any gain or loss. Tax Facts applies that literally: if any amount of gain is recognized in a section 1031 exchange, Form N-289 cannot be used, and its example of an exchange that includes $50,000 of stock requires the buyer to withhold the full 7.25% of the amount realized.

Form N-288B, the withholding certificate, does not fix this. Section 235-68(e) allows a certificate only where the seller will realize no gain or where proceeds are too small to cover the withholding after costs and liens, and the application must be filed at least 10 working days before the transfer.

Hypothetically, a $1,200,000 sale with $60,000 of planned boot means about $87,000 withheld rather than nothing, recovered through Form N-288C or the return. Run your own numbers with your CPA. Decide whether you need cash from the deal before contracts are signed, because cash and debt relief are both boot; see what boot means.

Getting excess withholding back

The seller can claim the withholding on the Hawaii income tax return after year end, or apply sooner for a tentative refund on Form N-288C when the return for the year of sale is not yet available. A seller who receives an N-288C refund must still file the return.

Only the seller can ask. Tax Facts says an escrow company cannot apply for a refund even of an amount it remitted in error, because the payment is credited to the seller's account. Keep the closing statement, depreciation records and improvement invoices; the Department does not accept oral statements or estimates from memory on N-288B or N-288C.

Foreign sellers clear FIRPTA separately, and the conveyance tax still applies

A seller who is a foreign person also faces federal FIRPTA withholding, which HARPTA was modelled on. The IRS FIRPTA exceptions page allows the seller to give the buyer a notice under Reg. section 1.1445-2(d)(2) that no gain is recognized because of a nonrecognition provision, and the buyer must file a copy with the IRS by the 20th day after the transfer. The federal process, including Form 8288-B under Reg. section 1.1445-1, is on the FIRPTA page.

Neither certification affects Hawaii's conveyance tax, which the seller pays on Form P-64A and which has no exchange exemption; see the Hawaii conveyance tax page. The income tax on the sale is on the Hawaii 1031 exchange page.