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.
No General Excise Tax or Transient Accommodations License. Some owners do not appear to be aware of Hawaii's tax regime for vacation rentals or have considered it in their investment decisions. Short-term rentals (lease less than 180 days) are subject to both general excise and transient accommodations taxes. General excise tax is 4.5% in Honolulu (4% other counties) and transient accommodations tax is 9.25%. These amounts are applied on a gross proceeds basis. Operating without a license and registration is illegal and subject to several civil and criminal penalties.
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 process is recommended.
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 this context, 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.
Common problems when a property manager is involved:
Complete Non-Compliance: Monthly and annual rental activity statements reflect taxes are billed to and collected from renters, and the amounts, but in fact no returns have been filed or taxes remitted;
Partial Non-Compliance: Property manager files periodic returns and remits taxes, but annual reconciliation returns are never filed; and,
Inaccurate Returns: Property manager files returns and remits taxes, but only on activity the property manager is aware of. Owner's own activity is not reflected on returns and is not paid.
Owners 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 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 is subject to Hawaii income tax filing requirements, whether it generates a tax liability or not. Owners and operators of Hawaii vacation rentals should be timely filing appropriate income tax returns annually. Failure to file income tax returns can drive up the expense of compliance and lead to a number of additional complications including audit and the imposition of income tax, penalties and interest.
The first thing is to realize that these problems are relatively common. Depending on the problem, you should contact an attorney, CPA, or EA (Enrolled Agent) familiar with Hawaii's tax laws and particularly tax issues relating to rental properties. Your own return preparer could be a resource in this process. Second, 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. Because general excise and transient accommodations taxes are computed on a gross receipts basis, the amounts can become significant economically, especially when penalty (25-50%) and interest (8% per year) is added. Careful thought should be given to how to qualify for a potential remission.