The Augusta Rule and Tax-Free Rental Income

Augusta Rule is a little-known tax loophole that allows taxpayers to exclude rental income from income tax per Section 280A(g) of the Internal Revenue Tax Code. There are two following common ways to benefit from Augusta Rule 280a. 

First, if you have a business under C corp or S corp, you can get tax-free money from your company by renting your entire home to your C corp or S corp up to 14 and get a huge tax deduction.

For example, let’s say you rent your entire house to your S Corp to host a Board of Directors meeting for two weeks. The average daily rent for such a house in your neighborhood is $1,000 per Airbnb. And your S Corp pays $14,000 to you as a homeowner for the rent. That generates an additional $14,000 deduction for your S Corp. But you don’t have to pay taxes for that money on your personal income if you rent your house for 14 days or less during the year. Usually, rental income is taxable as any other income. Keep in mind that Agusta Rule is not the same as Home Office Deduction, but it can be an additional deduction. 

Second, you can rent your home, a dwelling that qualifies as your main residence, for up to 14 days. And you don’t have to pay taxes on it. Since that income is not taxable, you don’t have to report it.

For example, let’s say you rent your entire main residence for two weeks through Airbnb for $10,000 while you are on a travel. Although rental income is taxable, you don’t have to pay taxes on that $10,000 if you rent your house for 14 days or less during the year.

We have explained all the details and requirements of the Augusta rule in the following paragraphs below.

What is the Augusta Rule?

The Augusta Rule, Section 280A(g) of the Internal Revenue Code (IRC), the provision allows a homeowner to rent their home for up to 14 days a year without reporting the rental income on individual tax returns. If you are looking for great tax planning tools, especially if you own a small business or self employed, the Augusta Rule may be your answer.

Why is the Exemption Called the “Augusta Rule”?

The residents of Augusta, Georgia, lobbied for the Augusta rule IRS exemption in the ’70s. The Masters’ golf tournament is held in Augusta each year at the Augusta National Golf Club. The city’s residents wanted to rent out their homes to tournament attendees without the hassles of becoming full-fledged rental businesses. They worked hard, and it paid off. The tax code added Section 280A. Today, homeowners in the US can use the IRS Augusta Rule as it’s not limited to just homeowners in Augusta, Georgia.

How to Use the August Rule?

These are the steps for small business owners to rent their house to their business per Augusta rule.

1. Form a business entity: First, you’ll need to form a legal business entity for your business, such as an LLC or corporation, to rent your house to. This will allow you to separate your personal and business assets and protect you from liability. It is highly recommended to file an S Corp election for your LLC. 
2. Draft a simple lease agreement: Next, you’ll need to draft a lease agreement between your business and yourself as the landlord. The lease agreement should include the rental amount, lease duration, and any other terms and conditions you’d like to include. If you cannot do a lease agreement, you should issue an invoice to your business for the use of your house.
3. Use fair market rent: To comply with the Augusta Rule, you must charge a fair market rent for your property. This means that the rental amount should be comparable to similar properties in your area and should not be artificially inflated.
4. Transaction: Make sure there is an actual transaction (payment) between your business and you as a landlord.
5. The 14-day provision. Make sure you rent your house for less than 15 days for the whole year. 
6. Keep accurate records: It is critical to keep accurate records of all transactions related to your property rental. This will be useful for tax purposes and for proving that you are legitimately operating your business.

Please note that the Augusta rule is not a tax law but a tax strategy, and it’s highly recommended to consult a tax professional before taking action.

How the Augusta Rule Works

Basically, the Augusta Rule means that short-term rentals of your personal residence are not taxable income. However, short-term, in this case, refers to rentals of less than 15 days. There is some “fine print” to this rule that needs to be noted.

• The rental has to be in the personal residence of the taxpayer. It can be a house, condo, apartment, boat, mobile home, or some other similar property as long as the taxpayer uses the dwelling as their residence.
• The Augusta Rule exemption applies to primary homes, secondary houses, and vacation homes.
• The 14-day provision is cumulative. This means it does not have to be consecutive. So, if your primary residence is located close to a popular wedding venue, you have the option of renting your home to guests for different wedding events throughout the year. It will still qualify as long as you do not exceed the 14-day limit.
• Rental prices must be reasonable for the location, date, or event. For instance, if you live near a large venue, you may rent your home as a smaller one for $150 a night during most of the year. But if there is a large event like the Super Bowl, you can charge the going rate based on the demand.

Disallowed Deductions on Employee Rental to Employer

Section 280A(c)(6) disallows rental deductions to the employee who rents his or her home to the employer. 

Does the August rule still work if you rent your home to S-Corp and you are on the payroll?

Section 280A(c)(6) disallows rental deductions to the employee since under the 14-day free-rent rule, the tax code does not allow the homeowner to claim any tax deductions. Using Agusta rule business owners are generating a huge business deduction and receipt of tax-free rental income.

Don’t Rent Your Home for Corporate Entertainment Purposes

In general, the entertainment facility rules disallow deductions for a facility used for entertainment, and that disallowance would be a problem for the Augusta rule strategy. So don’t rent the home to your corporation for any entertainment use.

However, there’s one exception in the entertainment facility disallowance rule. It does not apply to the annual employee holiday party or summer picnic.

Ordinary and Necessary Business Expenses

The rental of space for business meetings and the annual employee holiday party is an ordinary and necessary business expense. There is a clear business purpose for the S corporation’s rent payment in all these examples above.

The IRS privately ruled that the S corporation’s deduction for a rental payment to one of its shareholders can’t exceed the residence’s fair rental value for the activity. That is why rental payment from the S Corp must be a fair rental value. To justify the deduction in case of an IRS audit, you must document that the business activity took place. For example, take photos and have them processed so that the date of processing shows on the prints.

Does the Rental Income Need to Be Reported on Tax Returns?

The exempt rental income doesn’t have to be reported on your tax return. Make sure to keep good records, so if you are questioned, you can prove the following:

• You own the home (or owned it at the time of the rental)
• Your rates were at the market value, and
• You use the residence for personal use during the rest of the tax year.

Using Rental Websites

For those who are not sure how to advertise to renters, or are concerned about liability, a rental website like Airbnb or Vrbo may be worth checking out. One advantage of using these types of websites is tracking rent prices and dates if the IRS was to make an inquiry.

Check Your Local Regulations

Make sure to research your local regulations before you rent out your residence. Some local municipalities often have conditions or restrictions on short-term rentals.

Plan Rentals Strategically

Charging market rent prices is important when using the Augusta Rule. But you want to get the most out of the 14-day rent rule. A little research reveals market peaks throughout the year in your region. You make more tax-free money during periods when rental prices are typically high.

Great Tax Planning Opportunity

One of the most appealing aspects of the Augusta Rule is how it can shift income from a small business. When you do it correctly, you can rent your home out to your small business. This means you get a tax deduction for your business and the exclusion from income at the individual level. How does that work? Let’s look at another example.

Say you are one of the owners of a small business. The business rents your vacation home for a three-day weekend so they can conduct a planning retreat. You rent it out at market value. The business deducts the price of the rental as a business expense. Since you only rented it for three days at market rates, it is exempt from reporting on your personal income tax return. Make sure you and the business keep good records of the details. There should also be some records of the business the team conducted while they were using the rental. It’s a win-win.