Identical bills were introduced in the Hawaii House (H.B. 1012) and Senate (S.B. 1228) in January 2017 proposing to disallow for 15 years the dividends paid deduction (DPD) for real estate investment trusts (REITs) for tax years beginning after December 31, 2017. A DPD, however, would be allowed for dividends generated from affordable housing properties. Under the Internal Revenue Code of 1986, as amended (IRC), unlike other corporate taxpayers, a REIT may deduct dividends paid to its shareholders in calculating taxable income.¹ In order for a REIT to claim the DPD, it must distribute 90% of its taxable income.² "Taxable income" is calculated prior to DPD and excludes any net capital gain as well as net income from foreclosed properties.³

History of Hawaii REIT legislation

Such legislation is not new to Hawaii. In 2014, 2015 and 2016, legislation was introduced that would have repealed the DPD for REITs. In 2014, H.B. 1726 passed the House, but was deferred by the Senate. In 2015, several bills were introduced by members of the House and Senate to do the same thing. Following a number of committee hearings, the Senate passed a revised version on April 30, 2015, which funded a study on "the impact of real estate investment trusts in Hawaii and the possible effect of repealing the dividends paid deduction for real estate investment trusts."⁴ The revised version of S.B. 118 became law on July 15, 2015, without the Governor's signature.

The Hawaii Department of Business, Economic Development & Tourism (DBEDT), with the assistance of the Department of Taxation (DOTAX) released a preliminary analysis in an interim report dated December 8, 2015, finding that "assuming 95% of the REIT dividends were distributed to shareholders, the [Hawaii] corporate income tax forgone was estimated to be $16.3 million in 2014."⁵ In its final analysis, dated September 2016, DBEDT reached similar conclusions, finding that "estimated corporate income tax revenues foregone by the State of Hawaii, due to the REIT DPD, were approximately between $0.3 million for 2009 and $36 million for 2014 ($35 million after accounting for offsets from state taxes paid by Hawaii residents for REIT dividend income)."⁶ Section 1 of HB 1012 describes the concerns.⁷

Implications

In practice, the repeal of the DPD would result in most REITs being subject to tax on their entire taxable income as determined under the IRC's corporate income tax provisions⁸ that is apportioned to Hawaii. Moreover, eliminating the DPD would result in REITs falling into higher Hawaii corporate tax brackets and paying significantly higher taxes.

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ENDNOTES

¹ IRC Section 857(b)(2)(B).

² Id. Sections 857(a)(1)(A)(i) and (b)(2)(D).

³ Id.

⁴ 2015 Haw. S.B. 118, Section 1.

⁵ Haw. Dept. of Bus., Econ. Dev. & Tour., Research and Economic Analysis Division, Real Estate Investment Trusts in Hawaii: Preliminary Data and Analysis, Interim Report, (Dec. 2015).

⁶ Haw. Dept. of Bus., Econ. Dev. & Tour., Research and Economic Analysis Division, Real Estate Investment Trusts in Hawaii: Analysis and Survey Results, (Sept. 2016).

⁷ 2017 Haw. H.B. 1012, Section 1 "The legislature finds that, under current law, real estate investment trusts are entitled to a deduction for dividends paid. This deduction results in the loss of potentially millions of dollars of tax revenue to the State each year. The [Hawaii] department of business, economic development, and tourism estimates that, in 2014, this deduction resulted in $36,000,000 in corporate income tax revenue being forgone. If dividends paid by real estate investment trusts were not deductible, the dividends would be effectively taxed prior to distribution. This is significant because trust shareholders who reside in other states receive dividends from the trust, but pay taxes on those dividends to those other states. It should be noted that very few Hawaii taxpayers (between [0.5 % and 3%]) invest in real estate investment trusts with property in Hawaii. As a result, a number of states other than Hawaii receive tax revenue, leaving Hawaii taxpayers to essentially subsidize the costs of the infrastructure and government services that support properties owned by these trusts. Therefore, the legislature further finds that repealing the current deduction would promote fairness in the treatment of similar, but differently organized, business entities and would generate additional revenue for state programs.

"The legislature further finds that, given the State's affordable housing crisis, action must be taken sooner, rather than later, to provide more revenue to the State and relieve the pressures of this crisis.

"The purpose of this Act is to temporarily disallow the deductions for dividends paid by real estate investment trusts for a period of [15] years, but with an exception for dividends generated from trust-owned housing that is affordable to households with incomes at or below [200%] of the median family income, as determined by the United States Department of Housing and Urban Development.")

⁸ Hawaii Rev. Stat. tit. 14, Section 235-71(d).