SB1793 HD1

Report Title:

Sale of Leased Fee Interest; Tax-Exempt Capital Gains; Repeal of Mandatory Leasehold Conversion

Description:

Exempts from income taxation 100% of gains realized by lessors from sale of leased fee interest in multi-family leasehold residential properties and residential leasehold house lots to lessees; repeals mandatory leasehold conversion law. (SB1793 HD1)

THE SENATE	S.B. NO.	1793
TWENTY-THIRD LEGISLATURE, 2005		S.D. 2
STATE OF HAWAII		H.D. 1

A BILL FOR AN ACT

relating to leasehold conversion.

BE IT ENACTED BY THE LEGISLATURE OF THE STATE OF HAWAII:

PART I

SECTION 1. The legislature finds that, in 1967, in response to ideological forces fighting an oligopolistic land tenure system in Hawaii and spurred on by more practical reasons of increasing lease rents on renegotiations, the legislature enacted Act 307, Session Laws of Hawaii 1967 (Act 307), codified as chapter 516, Hawaii Revised Statutes, relating to residential leaseholds.

Chapter 516, Hawaii Revised Statutes, allows lessees of long-term leasehold interests in single-family residential development tracts the right to purchase the fee interest in their residential lots through a condemnation process involving the fee simple landowner and the housing and community development corporation of Hawaii. The latter party would condemn the fee interest, pay the fee owner fair compensation for the fee interest and, in turn, sell the acquired fee interest to the leasehold homeowner.

In 1984, following extended litigation, the United States Supreme Court ruled in Hawaii Housing Authority v. Midkiff, that Act 307 did not violate the United States Constitution. Shortly thereafter, in Hawaii Housing Authority v. Lyman, the Supreme Court of Hawaii also found that Act 307 did not violate the State Constitution. As a result, over the last twenty-five years, the number of leasehold single-family residences fell from a high of approximately twenty-eight thousand to four thousand six hundred.

The legislature also finds that, following the successful effort in substantially reducing the leasehold system in Hawaii as applied to single-family dwellings, many owners of multi-family residential leasehold units facing lease rent renegotiations, including cooperative housing corporations, condominiums, and planned development housing, aspired to obtain the right to purchase the fee interests under their multi-family units. Over the years, numerous bills were introduced to establish the right of a multi-family unit leasehold owner to purchase the fee interest, culminating in 1991 with two bills introduced in the legislature proposing mandatory leasehold conversion for multi-family units or, in the alternative, giving the lessor the option of leasehold conversion or lease rent control. Neither bill passed the legislature.

However, in 1991, the Honolulu city council adopted ordinance 91-95, which granted multi-family residential leaseholders the right to purchase the fee simple interest to their units in a condemnation procedure similar to chapter 516, Hawaii Revised Statutes. The new ordinance, codified in chapter 38, Revised Ordinances of Honolulu (Chapter 38), provided that at least twenty-five of the condominium owners (defined as owner-occupants) or at least owners of fifty per cent of the condominium units within the development, whichever was less, could trigger the condemnation process by the city department of housing and community development. Following the inevitable court challenge, the United States Ninth Circuit Court of Appeals, in Richardson v. City and County of Honolulu, held the ordinance did not violate the United States Constitution. In 2002, in Coon v. City and County of Honolulu, the Hawaii Supreme Court upheld the validity of chapter 38. However, in so doing, the court also held that the rules adopted to implement chapter 38, relating to determining the minimum number of applicants required to initiate the conversion process, violated chapter 38 by impermissibly lowering the minimum number of applicants required.

This prompted the Honolulu city council to attempt to amend chapter 38 in 2002 by introducing Bill 53, which would bring chapter 38 in line with the liberal rules for triggering the conversion process, consequently making it as broadly applicable as possible. However, this time the proponents were met by a more organized effort by fee owner lessors seeking to keep the conversion process comparatively narrow by excluding as many multi-family projects as possible from the process established in chapter 38.

In response to this opposition, the Honolulu city council tabled the measure.

In January 2005, after decades of heated debate between proponents and opponents of mandatory residential leasehold conversion, the Honolulu city council voted to repeal chapter 38, and in February 2005, the mayor of the city and county of Honolulu approved the repeal measure.

The legislature believes that, rather than perpetuate a process that polarizes members of the community, an incentive-based approach to the issue should be pursued. To this end, the legislature believes that providing fee owners of multi-family residential leasehold property with the opportunity, for a limited time, to exclude one hundred per cent of any proceeds from the sale of the leased fee interest to the lessee from their taxable income, would provide the proper incentive to sell the fee interest in their real property.

The purpose of this part is to allow, for a limited time, a fee owner to exclude from the fee owner's taxable income the capital gain realized from the sale of a leased fee interest in a multi-family residential leasehold property or a residential house lot to the:

(1) Lessee of the multi-family residential leasehold unit or residential house lot;

(2) Association of apartment owners of the multi-family residential leasehold building; or

(3) Residential cooperative corporation for the multi-family residential leasehold building.

SECTION 2. Section 235-7, Hawaii Revised Statutes, is amended by amending subsection (a) to read as follows:

"(a) There shall be excluded from gross income, adjusted gross income, and taxable income:

(1) Income not subject to taxation by the State under the Constitution and laws of the United States;

(2) Rights, benefits, and other income exempted from taxation by section 88-91, having to do with the state retirement system, and the rights, benefits, and other income, comparable to the rights, benefits, and other income exempted by section 88-91, under any other public retirement system;

(3) Any compensation received in the form of a pension for past services;

(4) Compensation paid to a patient affected with Hansen's disease employed by the State or the United States in any hospital, settlement, or place for the treatment of Hansen's disease;

(5) Except as otherwise expressly provided, payments made by the United States or this State, under an act of Congress or a law of this State, which by express provision or administrative regulation or interpretation are exempt from both the normal and surtaxes of the United States, even though not so exempted by the Internal Revenue Code itself;

(6) Any income expressly exempted or excluded from the measure of the tax imposed by this chapter by any other law of the State, it being the intent of this chapter not to repeal or supersede any such express exemption or exclusion;

(7) Income received by each member of the reserve components of the Army, Navy, Air Force, Marine Corps, or Coast Guard of the United States of America, and the Hawaii national guard as compensation for performance of duty, equivalent to pay received for forty-eight drills (equivalent of twelve weekends) and fifteen days of annual duty, at an:

(A) E-1 pay grade after eight years of service; provided that this subparagraph shall apply to taxable years beginning after December 31, 2004;

(B) E-2 pay grade after eight years of service; provided that this subparagraph shall apply to taxable years beginning after December 31, 2005;

(C) E-3 pay grade after eight years of service; provided that this subparagraph shall apply to taxable years beginning after December 31, 2006;

(D) E-4 pay grade after eight years of service; provided that this subparagraph shall apply to taxable years beginning after December 31, 2007; and

(E) E-5 pay grade after eight years of service; provided that this subparagraph shall apply to taxable years beginning after December 31, 2008;

(8) Income derived from the operation of ships or aircraft if the income is exempt under the Internal Revenue Code pursuant to the provisions of an income tax treaty or agreement entered into by and between the United States and a foreign country, provided that the tax laws of the local governments of that country reciprocally exempt from the application of all of their net income taxes, the income derived from the operation of ships or aircraft that are documented or registered under the laws of the United States;

(9) The value of legal services provided by a prepaid legal service plan to a taxpayer, the taxpayer's spouse, and the taxpayer's dependents;

(10) Amounts paid, directly or indirectly, by a prepaid legal service plan to a taxpayer as payment or reimbursement for the provision of legal services to the taxpayer, the taxpayer's spouse, and the taxpayer's dependents;

(11) Contributions by an employer to a prepaid legal service plan for compensation (through insurance or otherwise) to the employer's employees for the costs of legal services incurred by the employer's employees, their spouses, and their dependents; [~~and~~]

(12) Amounts received in the form of a monthly surcharge by a utility acting on behalf of an affected utility under section 269-16.3 shall not be gross income, adjusted gross income, or taxable income for the acting utility under this chapter. Any amounts retained by the acting utility for collection or other costs shall not be included in this exemption[.]; and

(13) One hundred per cent of the gain realized by a fee simple owner from the sale of the leased fee interest:

(A) In a multi-family residential leasehold property to the:

(i) Lessee of the multi-family residential

leasehold unit;

(ii) Association of apartment owners of the

multi-family residential leasehold building; or

(iii) Residential cooperative corporation for the

multi-family residential leasehold building; or

(B) In a residential leasehold house lot to the lessee of the residential leasehold house lot;

provided that the term "fee simple owner" shall include "legal and equitable owners" and that the terms "fee simple owner", "legal and equitable owners", "leased fee interest", and "lessee" have the same meanings as defined in section 516-1; and provided further that the terms "multi-family residential leasehold property" and "multi-family residential leasehold unit" mean property or a unit within a planned unit development, or a "condominium project" or "cooperative project" as those terms are defined in section 514C-1."

PART II

SECTION 3. Chapter 516, parts II, IV, and V, Hawaii Revised Statutes, are repealed.

SECTION 4. This part does not affect rights and duties that matured, penalties that were incurred, and proceedings that were begun, before its effective date.

PART III

SECTION 5. Statutory material to be repealed is bracketed and stricken. New statutory material is underscored.

SECTION 6. This Act shall take effect on July 1, 2050, and part I shall apply to taxable years beginning after December 31, 2050, and ending prior to January 1, 2056; provided that:

(1) Part II of this Act shall take effect on July 1, 2006; and

(2) This Act shall be repealed on January 1, 2056, and the underlying provisions of section 235-7(a), Hawaii Revised Statutes, shall be reenacted in the form in which they read on the day prior to the effective date of this Act.