A 1031 exchange is a tax strategy that allows you to defer paying capital gains taxes when you sell an investment property, as long as you reinvest the proceeds into a new, like-kind property. This means you can sell one property and buy another similar one without immediately paying taxes on any gains from the sale.
These like-kind exchanges are covered under Section 1031 of the Internal Revenue Code (hence the name "1031 Exchanges") and apply to federal capital gains taxes. However, each state has their own tax code, and may have different rules for real estate tax withholdings, the ability to complete a tax-deferred sale, or the rules around like-kind exchanges. Below we'll dive deep into these state-level specifics.
In Hawaii, the real estate tax withholding rules under the Hawaii Real Property Tax Act require a withholding of 7.25% of the amount realized on the disposition of Hawaii real property by nonresident persons. However, there are exemptions available:
These rules ensure that the appropriate amount of tax is withheld on real estate transactions involving nonresident sellers, while also providing avenues for exemption in certain situations. For more detailed information, you can refer to H.R.S. §235-68 and the Hawaii Department of Taxation's website.
While the federal government taxes capital gains at a lower rate than regular personal income, states usually tax capital gains at the same rates as regular income - this is not the case in Hawaii, which utilizes a lower rate than its personal income tax rate. The Combined Rate accounts for Federal, State, and Local tax rate on capital gains income, the 3.8 percent Surtax on capital gains and the marginal effect of Pease Limitations (which increases the tax rate by 1.18 percent).
Hawaii allows any taxpayer, other than a corporation, acting as a business entity in more than one state who is required by this chapter to file a return to elect to report and pay a tax of 0.5% of its annual gross sales (1) where the taxpayer's only activities in this state consist of sales; and (2) who does not own or rent real estate or tangible personal property; and (3) whose annual gross sales in or into this state during the tax year is not in excess of $100,000. Haw. Rev. Stat. § 235-51 (2015).
Many states recognize and follow the federal rules for a qualifying 1031 exchange. We recommending reviewing these resources for 1031 exchanges at the federal level - learn about the rules for an exchange, the key deadlines you must meet, and why you are required to work with a Qualified Intermediary like Deferred.com.
When considering a 1031 exchange for a property located in Hawaii compared to other states in the U.S., there aren't fundamental differences in how the 1031 exchange rules apply. The same general principles of the Internal Revenue Code Section 1031 apply, which allow for the deferral of capital gains taxes when you exchange one investment property for another of like-kind.
However, there are a few unique considerations when dealing with properties in Hawaii:
While these factors may add layers of consideration, they don't change the fundamental way a 1031 exchange is conducted. It's always important to work with professionals who understand both the local market and the specific requirements of Section 1031 to ensure that the exchange process goes smoothly and complies with all applicable laws and regulations.
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