Two years ago the state Legislature wanted to know the value of a Hawaii tax deduction that benefits one group of real estate investors. Now they know, and it’s way higher than they previously estimated.
A new state report estimates that real estate investment trusts, or REITs, saved $36 million on Hawaii corporate income taxes in 2014 — not $16 million as estimated in a preliminary report sent to the Legislature last December.
Both reports were produced by the state Department of Business, Economic Development and Tourism in response to a 2014 directive from lawmakers considering whether Hawaii should eliminate a tax deduction for REITs to boost income for the state.
Earlier this year three bills that proposed eliminating the tax deduction were introduced at the Legislature, but none got hearings.
The new data could encourage lawmakers to revisit the issue next year, though the updated report also casts doubt on whether the state would actually capture additional income by eliminating the deduction because affected companies might shift tax strategies.
About 40 REITs operate in Hawaii. They are mainly mainland companies that own prime retail, hotel, office and other commercial real estate.
REITs were established in 1960 by Congress as a way for small investors to own stakes in big income-producing properties. These stakes are often held through stocks in mutual funds.
Hawaii isn’t unique in its REIT tax deduction, which is called the “dividends paid” deduction and applies to income that REITs must pass to shareholders and can’t keep for their own corporate use. This deduction mirrors the tax treatment at the federal level along with every state except New Hampshire.
Shareholders shoulder this income tax burden for REITs because REITs by law must distribute at least
90 percent of their income to shareholders. There are also other restrictions on REITs, which is why all big real estate investment companies aren’t REITs.
Some local real estate industry executives contend that Hawaii is unduly harmed by the tax deduction because a vast majority of investors in REITs with property in Hawaii live on the mainland and therefore pay income taxes to other states when the income is derived from Hawaii property.
The National Association of Real Estate Investment Trusts has argued that it’s not fair to tax REITs on income they can’t retain, and noted that the state collects lots of taxes derived from mainland real estate through Hawaii residents who own stakes in REITs.
DBEDT’s report said 2,254 to 13,523 Hawaii households, or 0.5 to 3 percent of taxpayers, invest in REITs that have property in Hawaii, while 5,860 to 44,175 Hawaii households receive income from REITs with real estate outside of Hawaii.
REITs with Hawaii property include CNL Lifestyle Properties Inc. (Wet ’n’ Wild Hawaii), Taubman Centers (International Market Place), Forest City Realty Trust (Kapolei Lofts), Glimcher Realty Trust (Pearlridge Center) and General Growth Properties Inc. (Ala Moana Center, Whalers Village and Prince Kuhio Plaza). Others own hotels, public storage facilities, medical centers, office buildings, a college dormitory and mortgages.
Though DBEDT counted 42 REITs operating in Hawaii, the agency used a smaller number, 33, to estimate tax impacts with assistance from the state Department of Taxation.
In 2014 the 33 REITs had about $25 billion in U.S. income, of which about
$720 million was net income attributed to Hawaii. If these REITs had to pay Hawaii corporate income taxes, the bill would be $36 million.
In DBEDT’s preliminary report last year, it figured $16 million was the Hawaii tax impact of the deduction.
Estimates for the impact of the tax deduction from 2009 to 2013 either stayed the same or were a little lower in both reports, and ranged from $300,000 in 2009 to $10 million in 2013.
Paul Brewbaker, a local economist who produced a 41-page economic impact study on the tax issue for the REIT industry last year, said DBEDT’s dramatic revision for the tax impact in 2014 is suspect.
“The numbers are implausible,” he said, adding that DBEDT used crude methodology to arrive at its estimates.
DBEDT said it was able to make a better estimate by using Tax Department data from Hawaii tax filings in 2014 that weren’t available for the preliminary report. DBEDT said the big increase in 2014 REIT income attributed to Hawaii was due to capital gains.
Brewbaker said the only ones to benefit from eliminating the tax deduction will be traditional real estate companies that won’t have to compete with REITs if
REITs stop investing in Hawaii property.
In his report, Brewbaker said eliminating the deduction would encourage REITs to sell their Hawaii real estate and that likely buyers would be tax-exempt institutions such as pension plans, foundations and university endowments that, overall, would generate even less in Hawaii tax revenue.
DBEDT did caution in its report that capturing more tax revenue might not happen if the dividends-paid deduction is repealed. That’s because the state Tax Department expects REITs might adopt new tax strategies in the absence of the deduction.
“The Department of Taxation believes that if Hawaii eliminates the dividends paid deduction, taxpayers may respond in ways that reduce substantially any latent tax liability, such as by claiming other deductions that are presently not reported on their income tax returns,” the report said.
The report also surveyed REITs along with real estate companies that aren’t
REITs to gauge how REITs might react to Hawaii eliminating the tax deduction. REITs predicted that real estate investment in the state would decline 11 to 30 percent within five years. Other real estate companies predicted there would be no change in the same time frame.
