Wringing some new tax revenue from about 40 mostly mainland companies that own prime retail, hotel, office and other commercial properties in Hawaii has been put forth at the state Legislature in a move that also could affect the pocketbooks of small local investors with mutual funds.
The bills introduced recently take aim at a specific corporate structure called real estate investment trusts, or REITs, that Congress created in 1960 as a way for small investors to buy stakes in big income-producing properties such as shopping centers and office towers.
Hawaii lawmakers considered garnering more tax revenue from REITs last year, but after hearing a lot of divisive testimony, they instead passed a bill ordering the state Department of Business, Economic Development and Tourism to study the issue and present findings before the start of the 2016 legislative session.
DBEDT was allocated $90,000 to produce its report, which was only partially completed by the deadline but is expected to be finished in April about a month before the current legislative session ends.
The bills now up for consideration — House Bill 2073, Senate Bill 2492 and House Bill 82 — have not yet been scheduled for hearings.
All the bills propose eliminating a Hawaii tax deduction for REITs. Last year state lawmakers considered eliminating the deduction but failed to do so.
The deduction applies to income that REITs distribute to investors instead of retaining for corporate use. The deduction mirrors the tax treatment at the federal level along with every state except New Hampshire.
Instead of a REIT paying state income tax wherever the company owns property, investors who own shares in the REIT pay tax on the income they receive from the REIT, and this tax goes to states based on where each investor resides.
Under federal law, REITs must distribute at least 90 percent of their income to shareholders, which is a primary reason why the corporate-level tax deduction exists. There are also other restrictions on REITs, which is why all big real estate investment companies aren’t REITs.
Some local real estate industry leaders contend that too many REITs are making money in Hawaii and that nearly all the investors in these REITs live on the mainland, which unfairly benefits other state treasuries at the expense of Hawaii’s.
“We are giving away our state taxes to other states,” Peter Savio, a local commercial real estate investor said in written testimony on last year’s bill. “This needs to stop!”
Other supporters of the 2015 bill include several unions — such as the Hawaii State Teachers Association, which envisions more money being available to spend on public schools — local business leaders and the Hawaii Appleseed Center for Law and Economic Justice.
About 90 individuals or organizations submitted written testimony in favor of last year’s bill, including many who used the same form letter.
“We should level the playing field and tax REITs the same way as other real estate (companies),” Michael Fergus, a local commercial real estate investor, said in written testimony on last year’s bill.
REITs with Hawaii property include CNL Lifestyle Properties Inc. (Wet’n’Wild Hawaii), Taubman Centers (International Marketplace), 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.
Fergus estimated that REITs earn $700 million to $1 billion annually from property in Hawaii that would produce $30 million to $60 million in Hawaii income taxes annually if they weren’t REITs.
DBEDT’s report identified 36 REITs operating in Hawaii in 2014 and estimated that the forgone corporate income tax totalled $16.3 million that year, with prior year amounts ranging from $300,000 to $13.3 million between 2009 and 2013 assuming 95 percent of income went to shareholders.
Entities opposing last year’s bill were largely a handful of REITs along with the Building Industry Association of Hawaii, Hawaii Association of Realtors and principals from local real estate development firms Kobayashi Group and The MacNaughton Group.
“Apparently the premise is that REITs are bad for Hawaii because there are more mainland shareholders of the REITs doing business in Hawaii than there are Hawaii investors in REITs doing business outside of Hawaii,” Larry Taff wrote in testimony on the bill. Taff is president and CEO of the only Hawaii-based REIT on DBEDT’s list, Pacific Office Properties Trust Inc.
Dara Bernstein, senior tax counsel for the National Association of Real Estate Investment Trusts, said in written testimony that it’s not fair to tax REITs on income they can’t keep. She added that almost 11,000 Hawaii investors received roughly $100 million in taxable income from about 70 REITs with property mostly outside Hawaii, while other Hawaii residents own stock in REITs through mutual funds.
“The state is collecting taxes on the millions of dollars distributed to Hawaii investors by these companies and funds that invest in REITs, even though almost all of the properties held by these REITs are located outside of Hawaii,” Bernstein said.
REIT supporters and DBEDT noted that disallowing the Hawaii tax deduction would effectively tax investors in REITs twice on income tied to Hawaii properties.
Another notion raised in previous testimony is that REITs would exit Hawaii or reduce their investment in properties here if a bill to tax REIT income is passed.
General Growth, the Chicago-based owner of Ala Moana Center, said in testimony last year that it was considering spending $2 billion to further expand the mall and that this investment would be reconsidered if Hawaii’s tax rules on REITs are changed.
Honolulu resident Matthew Friedman said such claims shouldn’t be believed. “Should (General Growth) or any other REIT decide paying taxes on its Hawaii income is prohibitive, there would be a line of tax-paying non-REIT investors stretching as far as the eye can see waiting to buy those properties, thereby increasing the economic benefits to the state on any existing or future projects,” he said in written testimony.
Local economist Paul Brewbaker countered in testimony on the bill that the most likely replacements for REITs in Hawaii would be tax-exempt institutions such as pension plans, foundations and university endowments that, overall, would generate even less in Hawaii tax revenue.
Brewbaker, who recently produced a 41-page economic impact study on the tax issue for the REIT industry, also said REITs would be motivated to change the ownership structure for their Hawaii real estate in other ways to avoid the tax liability.
Brewbaker called the contemplated tax change ill-advised and said imposing a tax on income that a company can’t keep is like char—ging people to enter Disneyland and then charging them for each ride. “You would only do this if you intended to distort the pattern of ridership and to deter entry into the theme park,” he said.
