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There’s something awry in some new pieces of legislation that may well become law in July of this year. Because I’ve found no articles about this issue in the local print newspapers and because this legislation if passed has potential to hurt not only the non-resident property owners, but everyone who visits or lives in Hawaii, I would like to share critical details about this issue with your readers.
The legislation in question consists of four bills, three of which would require all non-resident (i.e. non-voting) owners to place their property under the complete management of a Real Estate Licensed Property Manager, who typically charges up to half or more of all the rental income as their fee. Today it is legal under Hawaii Real Estate code (HRS467) for an owner, regardless of residency, to manage their rental property directly, with the help of a local contact.
Critics say the bills would greatly increase their management costs while supporters argue that millions of dollars in revenue are leaving the state.
In reviewing all of the testimonies as well as the overall 2012 Legislative Agenda, what is clear is that at least some of the backers are the large Property Management firms. The only news running in the print newspapers suggests that these measures are to help collect taxes that are not paid, so it would sound like a good idea to someone who reads that. But the reality is that every owner who has a Permit and a Tax ID who is paying their taxes wants to open up their books for audits and these are the ones being penalized. The bills proposed, however, fail to provide methods to catch the people who are not already paying their taxes. The fatal flaw of the bills purported to collect taxes not paid is that they target only the law abiding tax paying owners and do nothing to identify the people who don’t have permits or who have never paid taxes. The other flaw is that resident owners do not also have the same scrutiny as non-residents, but one can understand that the same opportunity for “cheating” exists for any owner, not just non-residents.
Officials cite various reasons for writing this new legislation aimed only at non-resident owners, but upon careful review of all the facts, it appears there are several issues driving this change. First, it’s important to understand what is true and what is not.
Legislators maintain that the need for this law is to put a quash on “tax cheats” who rent their property but don’t report their income and pay their GE and TA taxes. Fact: The most recent report of the Department of Taxation dated November 2011 shows that 96 percent of the number of cases in litigation right now are with big firms like Property Management companies, Hotels and Time Share operations. 3.5 percent are cases by DOT for individual owners.
Also, the legislators have been told by the Attorney General not to pursue these bills as they are likely unconstitutional because it discriminates between resident and non-resident, and, while a month ago legislators passed early versions of the bills “citing studies” supporting their reasons for targetting non-resident owners, when asked for specifics they have never been provided. In fact, one Senator wrote back just a few days ago to say that she was unable to get a copy of a cited document from the Department of Taxation and suggested we now try to get this report on our own. What we do know, is the last statistical audit performed (by the Hawaii Tourism Authority in 2007) says non-residents ARE paying their taxes (the term was “generally in compliance” which meant a problem does not generally exist).
In the absence of a case that is convincing at least to non-resident owners, why they are being targetted, and why they alone should now be forced to turn over their properties to a Property Manager, let me explain how this will hurt these owners as well as everyone that has any income tied to this part of the tourism business. Here is a fictitious yet realistic and conservative example of what it would cost to operate a rental as I do today, on my own, and what would happen under the new laws if passed:
Self-managed Rental, earning $3000 rental income per month has the following expenses and remaining profit to be applied to mortgage, advertising and improvements or repairs. Monthly Expenses include $400 for GE/TA, $200 prop tax, $800 Condo Homeowner Fees, $300 Housekeeping, $150 various insurances, $300 utilities/phone/misc. What remains to pay for mortgage, advertising and repairs or improvements and any leftover profit: $850
Same Rental, under the new law, paying 40 percent to Property Manager (commission charges typically range from 20 percent to 50 percent plus other fees), earning $3000 per month. Monthly Expenses now include all the former ones plus $1200 commission to the Property Manager. So, before paying the mortgage, advertising to improve my occupancy (which is much worse under Property Managers than on my own), repairs, improvments, I am already IN THE RED by $350. Add a mortgage and maybe I’m loosing at least $2000 each month. There is no cushion for major repairs, Special Assessments, and definitely no easy way for owners to improve their properties with remodels, updated appliances, furniture, etc. So local businesses that sell supplies to these owners will soon see the results of this legislation’s fiscal impact on the rental business and then their own businesses.
Think of this as your employer telling you you just got a 40 percent paycut, and then you need to figure out how you are going to get by. This is exactly what this legislation means.
For the owners, many simply will not be able to pay this amount of money each month and they will be forced to sell. Hawaii’s real estate market, barely recovering from the downturn, will be flooded with unwanted units for sale. Sellers owing more than what they can sell the properties for, will most likely be doing short sales, foreclosures, and in worst case scenario, declaring personal bankruptcies – all due to this legislation. Due to the highly questionable constitutionality of the measures, and huge financial damages owners will suffer, Hawaii should brace for legal challenges all the way to the Supreme Court level. Hawaii’s taxpayers,unfortunately, will be on the hook to pay for the state’s legal defense.
Meanwhile, the local businesses who have supported the self-managed rentals in a service capacity, such as Housekeepers or Handymen will immediately lose their income when their former jobs are now hired out and managed by the Property Management firms or when the owner simply is forced to sell. Visitors who have repeatedly come to Hawaii because they have their favorite places to stay and enjoy their relationships with the owners may be looking to spend their vacation dollars elsewhere. This all will start to become very clear in July if these bills are enacted.
How does this help Hawaii? Is there not a better way?
The Department of Taxation and the Legislation surely must be able to find other ways to solve this problem than creating a larger problem for Hawaii by implementing laws of questionable constitutionality, that cause significant financial harm to non-resident owners, depress property values in Hawaii and hurt the state’s tourism.
A woman testifying against one of these TVR bills offered that Florida sets a good example, so before setting into motion some laws that will have some really bad consequences, we could learn from others. By one estimate Florida has about four times as many owner rentals than Hawaii, yet they seem to have a system in place to monitor tax compliance that works well for them and does not force owners to hire real estate agents. They employ three basic strategies, 1) have special programs that work between agencies, 2) enforce stiff fines for non-compliance, and 3) have a “whistle blowing” opportunity to expose cheaters.
In closing, I’ll share a little about my personal situation. Since I left the Rental Pool of my complex to self-manage my rental, my rental receipts have grown by 44 percent. I make more and Hawaii collects more — 44 percent more GE and TA from me. I’m happy with that and the Tax Department should be happy with that too. I ask you to consider, why would a “tax cheat” report 44 percent more revenue to the Department of Taxation when they are self- managing their own property?
So now it’s up to you to decide …. who or what do you think is flying under the radar? The non-resident owner “tax cheat”, the true agenda of the 2012 Legislation, or something else?
(If you would like to learn more about these measures, you can visit Hawaii.gov Measure Status (HB1706, HB1707, HB2078 and SB2089). The final hearing for HB2078 is Friday morning, Testimony is due Thursday, March 29 no later than 9 a.m. You can submit testimony or watch the measure status on this link.
About the author: Elen Stoops grew up in Southern California and lives in Northern California. She studied at UC Davis and Santa Clara University and has a career in Technology Sales. She and her family have been visiting the Hawaiian islands since she was a teenager. She was delighted when she was able to save for and then buy a vacation rental and share the dream of a Hawaii vacation with others. Elen enjoys organic gardening, yoga in California and Makawao HI, and hiking in the Sierras and on the beaches with her dog Buster.