Form N-289 and Non-Recognition Provisions
Updated: Jun 6, 2022
Once a home seller accepts an offer and goes into contract (also known as entering the escrow process), they are usually given a Form N-289. This is a Hawaii form, and the purpose of this is to claim an immediate exemption of the HARPTA withholding by making one of the 3 claims:
The home seller is a "Hawaii resident"
The sale is a "nonrecognition provision", or
The gross sales price is less than $300,000, and the home seller has lived in the home as their main home for at least the last 1 year
In this blog entry, I'm focusing on just the second reason: nonrecognition provisions. Here are a couple of definitions of "nonrecognition provisions":
Non recognition provision as applied in tax law refers to a statutory rule that allows all or part of a realized gain or loss not to be recognized for tax purposes. However, this provision only postpones the recognition of the gain or loss. (USLegal.com)
Nonrecognition provision generally have two common themes. First, nonrecognition is conferred because it is said that the sale or exchange at issue usually involves a mere change in the form of an investment and not a change in the substance of that investment. Second, the realized gain or loss usually never disappears: the unrecognized gain or loss typically carries into the new asset. When the new asset is sold or exchanged in a taxable transaction, the realized gain or loss from the first transaction will then be recognized. Preservation of the unrecognized gain or loss is accomplished by giving the new asset a cost basis equal to the adjusted basis of the old asset. Therefore, when you see a nonrecognition provision, you should expect to see some basis mechanism within that provision that preserves the unrecognized gain or loss. (https://en.wikipedia.org/wiki/Nonrecognition_provisions)
Some home sellers who have filled out the Form N-289 have mistakenly checked the second box and said in the description that they are exempt from HARPTA because they are military servicemembers who are transferring due to military orders. Or they list that they are subject to Section 121 gain exclusion rules, and therefore are immediately exempt. Neither explanation is appropriate for box 2 because neither Section 121, nor permanent changes of station ordered by the military are nonrecognition provisions. To claim an immediate exemption of HARPTA based on either reason is serious tax evasion that is punishable with large fines and even prison time.
Hawaii Tax Information Release 2017-01 (https://files.hawaii.gov/tax/legal/tir/tir17-01.pdf) lists the following types of dispositions as acceptable non-recognition provisions:
Section 1031 Exchanges (the most common nonrecognition provision, by far)
Sections 102 (relating to gifts/inherited property)
Section 332 & 337 (complete liquidations of subsidiaries)
Section 351 (transfers to corporations controlled by transferor)
Section 721 (nonrecognition of gain/losses on contributions)
Section 1041 (transfers between spouses or incident to divorce)
Escrow officers are generally not allowed to explain the meanings of the terms on any of the tax forms because of liability reasons. However, I'm always happy to discuss any and all topics related to HARPTA and FIRPTA. If you have any questions about Form N-289, please call us and I'll be happy to explain the form.