The Underwater Seller: HARPTA Withholding, Prorations, and a 1031 Exchange
Escrow opens September 2 and closes September 18 on a Honolulu condominium. Price $860,000; total commission 5%; seller's closing costs (title and escrow) $6,450; first mortgage payoff $812,400. The seller, a California resident who has never lived in Hawaii, bought the unit as a rental six years ago and plans a 1031 exchange into a Nevada property; she tells her salesperson, 'I'll pay my taxes next April - just don't let escrow hold back anything.' Real property taxes for the fiscal year July 1–June 30 are $3,120, billed in two equal installments; the first installment (covering July 1–December 31) was paid August 20; the second is not yet due. Conveyance tax is 10 cents per $100 on the first $600,000 of consideration and 20 cents per $100 on the excess. Prorations use the day of closing as the buyer's; the seller's last day is September 17.
1. Compute the Hawaii withholding and explain whether the seller may simply elect out of it.
Read the worked answer
The withholding is 7.25% of the gross sales price, not of the gain:
0.0725 × $860,000 = $62,350
It is not elective. Hawaii's nonresident withholding statute puts the duty on the purchaser/escrow to withhold and remit from the seller's proceeds unless a statutory exemption or a waiver or reduced-withholding certificate issued by the Hawaii Department of Taxation is presented at closing. A seller's promise to 'pay it next April' is not an exemption, and escrow that closes without withholding or a certificate creates liability exposure for itself and the buyer.
The legitimate path to a smaller number: the nonresident seller may apply to the Department of Taxation for a waiver or reduced withholding based on the actual Hawaii gain. Here the gain is thin - $860,000 less $812,400 payoff, commissions, costs, and her original basis. A certificate obtained before the closing date is the only thing that reduces the $62,350.
Two points the licensee should convey:
- The withheld money is a credit against her Hawaii nonresident income tax return, not an extra tax; over-withholding comes back as a refund.
- FIRPTA does not apply. She is a U.S. citizen, and FIRPTA's 15% withholding applies only to foreign persons. The licensee should confirm the withholding question with escrow at the open of escrow, not the week of closing, and should refer the tax analysis to her CPA.
2. Prepare the seller's side of the closing statement through the withholding line. What problem emerges, and what should the licensee and escrow do about it before September 18?
Read the worked answer
Conveyance tax: $600,000 ÷ 100 × $0.10 = $600; $260,000 ÷ 100 × $0.20 = $520; total $1,120.
Proration: the seller already paid the installment covering July 1–December 31, so the buyer owes the seller for the buyer's days. July 1–December 31 = 184 days; buyer's days September 18–December 31 = 105 days. $1,560 × 105 ÷ 184 = $890.22 credit to seller.
| Item | Amount |
|---|---|
| Sale price | $860,000.00 |
| Less commission (5%) | ($43,000.00) |
| Less conveyance tax | ($1,120.00) |
| Less seller closing costs | ($6,450.00) |
| Less mortgage payoff | ($812,400.00) |
| Plus property tax proration credit | $890.22 |
| Less HARPTA withholding | ($62,350.00) |
| Net to seller | ($64,429.78) |
The problem: the seller must bring roughly $64,430 in cash to a closing she believes will pay her. Withholding is computed on gross price, so a heavily leveraged seller can be cash-negative even with little or no gain.
What to do now:
- Have escrow run and deliver a seller's estimated closing statement immediately, with the withholding line shown.
- Advise the seller to file for a reduced withholding certificate with the Department of Taxation - that requires time, so the request must go in now, and escrow needs the certificate before closing.
- Get written acknowledgment of the cash requirement, in the seller's own signature, before the closing date.
- Escrow should not close without either the certificate or the funds; a seller who learns this on closing day is a failed closing and a possible claim.
- The licensee's role is to surface the issue and refer tax questions to the CPA - not to advise on withholding amounts.
3. How does the withholding interact with the planned 1031 exchange, and what must be in place on the closing date?
Read the worked answer
Constructive receipt kills the exchange. The seller must never have the right to receive, pledge, borrow against, or otherwise enjoy the proceeds. A qualified intermediary must be engaged in writing before closing, and the net proceeds must be wired to the QI - not to the seller and not to her agent or attorney.
The withholding reduces the cash that reaches the QI, which can leave her replacement-property debt and equity short:
- Best outcome: obtain a reduced or waived withholding certificate showing minimal recognized Hawaii gain, so nearly all proceeds reach the QI.
- Fallback: if $62,350 is withheld, deposit an equivalent amount of her own cash with the QI so the exchange remains fully funded, and recover the withheld amount as a credit on her Hawaii return.
Calendar and structure to confirm at closing:
- 45 days from closing to identify replacement property in writing; 180 days to acquire it (and note that the tax return due date can cut the 180-day period short if she files on time).
- Same taxpayer on both ends; the Nevada property must be held for productive use in a trade or business or investment.
- The QI must be a disinterested party - not her agent, not her attorney, not a relative.
- The exchange defers Hawaii tax; it does not eliminate it. Hawaii-source gain will surface on a later disposition or as boot.
The licensee's job is to make sure the QI is in place before the deed records and that escrow's instructions direct proceeds to the QI. The exchange's tax mechanics belong to the CPA.