The Hawaii real estate market continues to attract investors with its mix of lifestyle appeal and income-generating properties like apartment complexes and multi-family homes. If you're selling one of these investment properties and considering reinvesting through a 1031 exchange, understanding your net proceeds is critical to ensuring compliance with IRS rules and maximizing your tax deferral benefits.
In this post, we’ll explain how net proceeds factor into a 1031 exchange, break down the calculation process specifically for sellers of apartments and multi-family units in Hawaii, and offer guidance on how to plan your reinvestment to avoid unnecessary tax liability.
What Is a 1031 Exchange?
A 1031 exchange, named after Section 1031 of the Internal Revenue Code, allows investors to defer capital gains taxes when they sell a qualifying investment property and reinvest the proceeds into another “like-kind” investment property. For Hawaii investors, this means you can sell an apartment building in Honolulu and purchase a multi-family unit in Maui or even on the mainland as long as the properties qualify under IRS guidelines.
But to get full tax deferral, you must reinvest all net proceeds from the sale and replace any debt you paid off during the sale.
But to get full tax deferral, you must reinvest all net proceeds from the sale and replace any debt you paid off during the sale.
What Are Net Proceeds in a 1031 Exchange?
Net proceeds refer to the amount of money remaining after closing costs, liens, and mortgages are paid off from the sale of your relinquished (old) property. It’s essentially the amount that is available to roll into your replacement property.
Here's why it matters: if you don’t reinvest all of the net proceeds or if you take cash out, you’ll trigger a partial tax event known as “boot,” which can reduce the benefits of your 1031 exchange.
Here's why it matters: if you don’t reinvest all of the net proceeds or if you take cash out, you’ll trigger a partial tax event known as “boot,” which can reduce the benefits of your 1031 exchange.
Step-by-Step: Calculating Net Proceeds for a 1031 Exchange in Hawaii
Let’s break it down in a Hawaii-specific context. Say you’re selling a multi-family property in Oahu. Here’s how you calculate net proceeds:
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Start With the Contract Sale Price
This is the amount a buyer agrees to pay. For example: Sale Price: $2,000,000 -
Subtract Selling Expenses
This includes: Real estate commissions (typically 5 to 6 percent in Hawaii), Escrow and title fees, Attorney fees, Recording fees, Repairs and credits to the buyer. Let’s say these total around $120,000: $2,000,000 - $120,000 = $1,880,000 - Subtract the Mortgage Payoff
If you still owe on a mortgage or loan, subtract that from the balance.
- Example: Remaining mortgage: $800,000
$1,880,000 - $800,000 = $1,080,000
- Example: Remaining mortgage: $800,000
Your net proceeds are $1,080,000. This is the amount that must be fully reinvested into a replacement property to maintain full deferral of capital gains taxes.
Consider Hawaii-Specific Selling Costs
When selling real estate in Hawaii, a few additional costs can impact your net proceeds:
HARPTA (Hawaii Real Property Tax Act): Requires withholding of 7.25 percent of the sale price from non-resident sellers. However, it’s refundable if you file properly and show no gain or a qualifying 1031 exchange.
FIRPTA (Federal equivalent): Withholding of 15 percent for non-U.S. sellers.
These withholdings can be reclaimed through proper tax filings, but they will temporarily reduce the amount held in escrow, so your intermediary must be aware of them when calculating how much needs to be reinvested.
HARPTA (Hawaii Real Property Tax Act): Requires withholding of 7.25 percent of the sale price from non-resident sellers. However, it’s refundable if you file properly and show no gain or a qualifying 1031 exchange.
FIRPTA (Federal equivalent): Withholding of 15 percent for non-U.S. sellers.
These withholdings can be reclaimed through proper tax filings, but they will temporarily reduce the amount held in escrow, so your intermediary must be aware of them when calculating how much needs to be reinvested.
Replacement Property Considerations in a Hawaii 1031 Exchange
Once you know your net proceeds, you’ll need to ensure your replacement property meets IRS requirements:
Equal or Greater Value: If you sold for $2,000,000, the replacement property must be at least $2,000,000 to fully defer taxes.
Reinvest All Net Proceeds: In our example, the full $1,080,000 must go into the new purchase.
Replace Debt: If you paid off $800,000 in mortgage, you must take on a similar loan or bring in cash to offset the difference.
Let’s say you buy a replacement apartment building in Kona for $2.1 million and use all $1,080,000 of your proceeds, plus take on a new loan of $1,020,000. That would fulfill the 1031 exchange requirements and defer all taxes.
Equal or Greater Value: If you sold for $2,000,000, the replacement property must be at least $2,000,000 to fully defer taxes.
Reinvest All Net Proceeds: In our example, the full $1,080,000 must go into the new purchase.
Replace Debt: If you paid off $800,000 in mortgage, you must take on a similar loan or bring in cash to offset the difference.
Let’s say you buy a replacement apartment building in Kona for $2.1 million and use all $1,080,000 of your proceeds, plus take on a new loan of $1,020,000. That would fulfill the 1031 exchange requirements and defer all taxes.
Timing and Identification Rules
Don't forget the IRS deadlines:
45-Day Identification Rule: You must identify replacement properties within 45 days of the sale.
180-Day Purchase Rule: You must close on the new property within 180 days.
Your qualified intermediary (QI) will hold your net proceeds during this time, so you won’t have direct access to the funds. Choosing a local Hawaii QI familiar with state-specific issues like HARPTA is highly recommended.
45-Day Identification Rule: You must identify replacement properties within 45 days of the sale.
180-Day Purchase Rule: You must close on the new property within 180 days.
Your qualified intermediary (QI) will hold your net proceeds during this time, so you won’t have direct access to the funds. Choosing a local Hawaii QI familiar with state-specific issues like HARPTA is highly recommended.
Potential Pitfalls to Avoid
Even with a seemingly straightforward transaction, here are a few mistakes that can result in taxable “boot”:
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Not replacing debt: If you take cash out instead of financing a similar amount, you may owe taxes on the difference.
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Underestimating costs: Misjudging closing costs or forgetting HARPTA withholdings could lead to reinvesting too little.
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Co-mingling funds: Never deposit net proceeds into a personal or business account. They must remain in escrow or with a qualified intermediary.
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Buying a personal-use property: The replacement property must be used for business or investment purposes.
Planning Ahead: Work With Experts
Executing a successful 1031 exchange, especially with higher-value multi-family homes in Hawaii’s complex market, requires careful coordination. To maximize your net proceeds and ensure tax compliance:
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Hire a 1031 exchange facilitator (qualified intermediary)
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Consult a Hawaii-based real estate tax advisor or CPA
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Work with a local agent familiar with multi-family investments
By calculating your net proceeds early, you can shop for replacement properties with confidence and avoid surprises that could trigger unnecessary taxes.
Final Thoughts
A 1031 exchange is a powerful strategy to grow your real estate portfolio without taking an immediate tax hit, and understanding your net proceeds is the foundation of the entire process. For Hawaii apartment and multi-family property owners, the stakes are high but so are the opportunities.
With the right planning and expert support, you can leverage your Hawaii investment into a tax-deferred reinvestment and continue building wealth across the islands or beyond.
With the right planning and expert support, you can leverage your Hawaii investment into a tax-deferred reinvestment and continue building wealth across the islands or beyond.
Partner with Christina Dwight for Expert Real Estate Guidance in Hawaii
If you're navigating the Hawaii real estate market, Christina Dwight offers a depth of local knowledge and professional insight that sets her apart. Born and raised in the islands, Christina brings a lifelong connection to the community and a strong sense of kuleana — a personal responsibility to improve housing across the state.
Whether you’re selling or investing, Christina Dwight provides the clarity, relationships, and results that make all the difference in Hawaii’s dynamic market. Reach out today to start your journey with a true local expert.
Whether you’re selling or investing, Christina Dwight provides the clarity, relationships, and results that make all the difference in Hawaii’s dynamic market. Reach out today to start your journey with a true local expert.