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Buying A Hawaii Vacation Rental Property? Tax Considerations (Especially) For Non-Residents

Insight Published on 09 Dec 2020

Hawaii is a beautiful state with both well-developed resort districts and appealing serene residential neighborhoods.  Both residents and non-residents have recognized the investment and income potential that a Hawaii vacation rental property could provide.  I have noticed several common tax mistakes when leasing a Hawaii property to short-term tenants, particularly by non-resident owners.

Failure to Include Hawaii’s ‘Special’ Taxes In The Investment Model. 

Purchasing a vacation rental is essentially the purchase of a business.

Some owners do not appear to be aware of Hawaii’s tax regime for short-term or “vacation” rentals or to have considered it in their investment decisions. Short-term rentals (initial lease term less than 180 days) are subject to both general excise and transient accommodations taxes.  General excise tax is 4.5% in Honolulu (similar base with varying surcharges other counties) and transient accommodations tax is currently (2020) 10.25%. 

While this is a slight simplification, both of these taxes apply to the gross proceeds.  Thus, they are not “net” or “profit” taxes. 

It does not matter whether the property is in a resort district or elsewhere, these taxes will apply to short-term rentals.    Prospective operators should carefully consider whether they will be able to meet investment objectives while paying these taxes.

If the business model gets into trouble, there is a temptation to defer filing and payment of taxes, despite collecting the taxes from customers.  Hawaii’s late filing penalty rate is 5% a month to 25%, and interest is currently 8% annually.  Other penalties can apply.  Past-due balances can result further negative consequences.

Careful projections, adequate financial reserves, and discipline can help avoid getting into this situation.  For those already behind, professional advice may be of assistance.

Relying Upon On-Line Services For Tax Advice.  

Online travel booking services, or their forums, should not be considered reliable sources of tax advice.  Some of the services do not accommodate properly adding Hawaii’s taxes and, in my observation (2020), offer owners less than a complete picture of compliance.   While there has been substantial improvements especially over the past five years, online book services are not tax advisors.

Tax advisors should be relied upon for tax advice.

Licensed property management professionals should also be familiar with Hawaii’s vacation rental tax structure. 

Operating Without A General Excise Tax or Transient Accommodations License. 

Operating a vacation rental without a license and registration is illegal and subject to several civil and criminal penalties. 

The Hawaii Department of Taxation has criminally prosecuted vacation rental owners in the past for failure to file GE and TA returns.  Hawaii historically has pursued extradition of non-residents on tax misdemeanors.  Further, Hawaii courts in tax cases routinely file civil-type judgments to secure unpaid restitution obligations.  Property owners are relatively easy targets for lien filing and potential foreclosure of tax liens.

Registration or amending an existing registration can be done on-line with the Hawaii Department of Taxation.  Delinquent or past partial registration poses a number of problems and professional help from a CPA or attorney familiar with Hawaii’s tax laws and procedures is recommended.

The DoTax has obtained information from AirBNB via a subpoena procedure and is currently (2020) pursuing suspect operators that are not in compliance.

Delegating Tax Compliance To A Property Manager (Or Assuming They Will Handle It.)  According to numerous tax decisions from the U.S. Supreme Court to Hawaii’s courts, tax filing compliance is the responsibility of the taxpayer.  In the vacation rental context, this usually means the owner of the vacation rental.  Property management firms provide a variety of services, and some of them will prepare tax forms and remit taxes to the Department of Taxation on an owner’s behalf.   Unfortunately, communication breakdowns frequently occur for a variety of reasons. 

Common tax problems when a property manager is involved:

  1. Complete Non-Compliance: This speaks for itself:  no taxes are collected from visitors, no returns are ever submitted.  A second variation of (filing) non-compliance:  monthly and annual rental activity statements sent to the owners reflect taxes have been billed to and collected from renters, and the amounts, but in fact no returns have been filed or taxes remitted.  The owners do not realize from the statement that taxes have not been paid. 
  2. Partial Non-Compliance: Property manager files periodic returns and remits taxes to the Department, but annual reconciliation returns are never filed; and,
  3. Inaccurate Returns: Property manager files returns and remits taxes, but only on activity the property manager is aware of.  Owner’s own, independent, activity is not reflected on returns.

Owners using a property manager should have a written contract with the property management firm and should carefully review statements, especially initially.  The fact the property manager did not pay the taxes will generally not relieve the owner from the responsibility for those taxes and, unless a remission is granted, penalties and interest. 

Periodic and annual management statements can be disturbingly obvious when reviewed in hindsight.  If the annual return is not filed, the statute of limitations on an audit is not closed and compliance years or decades later can be burdensome, especially in the context of a property sale.  Property managers should be informed if the owner is undertaking their own rental efforts and tax filings coordinated accordingly. 

Owners should have a copy of the as-filed annual general excise (G-49) and transient accommodations (TA-2) form in their tax records.

Failure to File Appropriate Hawaii Income Tax Returns.  Vacation rental activity (or long term rental activity) is subject to Hawaii income tax filing requirements, whether it generates a tax liability or not.  Put another way, operating at a loss, does not excuse the obligation to file an income tax return.  Owners and operators of Hawaii vacation rentals should be timely filing appropriate income tax returns.   Failure to file income tax returns can drive up the expense of later compliance and lead to a number of additional complications.

Residents of states without a state income tax, such as Washington, Nevada, and Texas, are not excused from filing (non-resident) Hawaii income tax returns for Hawaii activities.

What Should You Do If You Have One Or More Of These Problems?

These problems are relatively common.  Depending on the extent and duration of the problem, you should contact an attorney or CPA familiar with Hawaii’s tax laws and particularly tax issues relating to rental properties for assistance in remedial action and appropriate procedure.   Your own return preparer could be a resource in this process. 

Next, defining the duties and obligations of the property manager can rectify past communication errors, and your property manager may have records extremely useful in getting into compliance.

Finally, the Department of Taxation has authority in limited circumstances and conditions to remit penalty and interest if specific requirements are met. 

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