This past year Alexander & Baldwin announced, like many Hawaii commercial real estate companies before it, that it too, would become a real estate investment trust.

At this rate, I too, would like to be a REIT, but alas, a REIT requires a minimum of 100 shareholders and I barely have that many Facebook friends.

The details of the taxation of REITs have been hashed through before in Civil Beat by Anita Hofschneider and Michael Fergus (one of the lone crusaders in this REIT fight), but here’s the CliffsNotes version.

C corporations (corporations that are taxed separately from its owners), like A&B, are traditionally subject to double taxation: corporate taxation and individual taxation.

Pass-through entities such as partnerships and S corporations (corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for federal tax purposes) are subject to one level of taxation, the individual level.

The Alexander & Baldwin building in downtown Honolulu. The company has moved to become a REIT.

Flickr: billsoPHOTO

Becoming a REIT for federal tax purposes allows a C corporation to be taxed like a pass-through entity, with one level of taxation, and that is, individual taxation. 

Where REITs differ from pass-through entities is for state income tax. Income earned on real estate in Hawaii is generally considered Hawaii sourced for pass-through entities, meaning the owners pay Hawaii income tax on the individual level on that income even if they’re non-residents.

That same income earned in a C corporation pays Hawaii income tax, but only at the corporate level. On the second layer of taxation, the individual level, the income is sourced to the state the owner is a resident of. For a REIT and its one layer of taxation, all the income is sourced to the state of residence of the owner, meaning if you’re a non-Hawaii resident, all your income from a REIT avoids Hawaii income tax. 

The result is out-of-state investors in Hawaii property are either subject to Hawaii income tax (if structured as a pass-through entity) or not subject to Hawaii tax (if structured as a REIT). Similarly, when an out-of-state investor purchases property directly in Hawaii and rents it out, the rental income is subject to Hawaii income tax.

New Reasons To Address The Issue

The REIT and state income tax issue has been studied and looked at by Hawaii lawmakers. But there might be a few new reasons to readdress the issue, including the addition of A&B (one of Hawaii’s largest real estate owners) to the REIT club for 2017. 

Another reason to rehash the issue is the new tax bill. The bill includes a 20 percent deduction for income coming from a pass-through entity, which also will include REIT payouts. It suddenly appears A&B shareholders are about to have a windfall of tax savings, particularly the out-of-state owners.

I like to think a tax break on the federal level might give Hawaii ample opportunity to sneak in there and increase Hawaii taxes before taxpayers get used to their new tax bill. 

The final reason is for tax year 2018, Hawaii brings back the top 11 percent marginal income tax rate, which is one of the highest state income tax rates in the nation.  That means that if two investors in A&B, one from Hawaii and one from Texas (no state income tax), get together, the Texan should be obligated to pick up the bill until Hawaii lawmakers figure out a way to level the playing field. 

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