Do you own a home? If so, you have an opportunity to generate tax-free income using the “Augusta Rule.” Named after its original scenario where residents of Augusta, Georgia, rent out their homes during the annual Masters golf tournament, this rule offers a valuable opportunity to earn tax-free income and deductions you don’t have to pay for by renting out your personal residence or vacation home.
Let’s dive into the Augusta Rule’s fundamentals, benefits, and prerequisites so you can implement this strategy while complying with IRS rules.
What is the Augusta Rule?
The Augusta Rule refers to Section 280A of the Internal Revenue Code (IRC), which allows homeowners to rent their property for up to 14 days annually without paying taxes on the rental income on their federal tax return.
This exemption applies even if the income received is substantial, as long as the property is rented for no more than two weeks and the owner uses it personally for over 14 days or 10 percent of the total days it is rented.
Some other requirements include:
- The home cannot be your primary place of business
- The rent you charge must be reasonable and in line with what the market supports
When to take advantage of the Augusta Rule
There are two ways to take advantage of the Augusta Rule potentially.
First, if you live in a vacation destination, own property in desirable locations during peak local events, or own a large or unique property that might be ideal for hosting special events, you can rent your home for up to 14 days, tax-free. Beyond the Masters golf tournament, many homeowners use this loophole during major sporting events, such as when the Super Bowl or a March Madness tournament comes to town.
However, you don’t have to rent your home out to strangers to take advantage of this legal tax loophole. If you own a business and don’t use the home as your primary place of business, you can hold a monthly meeting with your board of directors or host quarterly partner retreats at your home. The company can pay you a reasonable amount to rent the home for the day. As long as the total rental period doesn’t exceed 14 days over the course of a tax year, this is an effective strategy to generate a tax deduction for the business without having to report the income on your personal tax return.
Implementing the Augusta Rule: step-by-step guide
Proper planning and documentation are the keys to successfully leveraging the Augusta Rule. So here’s a step-by-step guide to applying it.
Step 1: Know the rules
Before renting out your home, understand the rules so your transaction will qualify for the exemption.
Here are the high-level requirements to keep in mind:
- The home can be your primary home or a second home as long as it’s not your primary place of business.
- You must use the property personally for more than 14 days or 10 percent of the total days it was rented to others at a fair rental price, whichever is longer. Otherwise, it’s considered a rental or investment property, and all rental income is taxable.
- The property must be in the U.S.—property in a foreign country doesn’t qualify.
- If renting the home to your business, it must be a corporation, partnership, or limited liability company (LLC) that files its own return.
You should also check local laws and homeowners’ association rules to ensure that short-term rentals are permitted.
Step 2: Plan the rental period
Choose a period that does not exceed the 14-day threshold. You don’t have to rent the property for 14 consecutive days—one day per month or a few days each quarter works.
However, if you exceed 14 rental days, all days the home is rented out become taxable.
Step 3: Set a competitive rental rate
The rent must be reasonable and supported by market research. Investigate comparable rental prices in your area to set a competitive rate.
You can consult websites like Airbnb and VRBO or consult with a real estate professional to price your rental accurately. If you do the research yourself, try to find properties similar to yours in location, size, and amenities. It is recommended that you find two to three comparable homes and take an average price per square foot before applying the rental rate to the square footage of your home. Make sure to keep printouts or other documentation to justify your research and keep it with your tax records.
Remember, while the income isn’t taxable, you can’t claim any expenses you incur in renting the property, so you might want to build those expenses into the rental rate.
Step 4: Advertise your rental
If you are not renting the property to your business, market it using online rental platforms, local advertising, or your professional network. There are even companies that will manage bookings and clean your home before and after the rental period to ensure it is in good order when you return.
Ensure potential renters understand the specifics of the rental agreement, including duration and amenities.
Step 5: Manage the rental process
Draft a formal rental agreement specifying the rental terms and conditions.
If you rent the home to your business, the business should issue a 1099-MISC to you at year-end for the rent paid. You still claim the income on your federal tax return, but it’s excluded from taxation under IRS Section 280(A).
Maintain detailed records of the rental period and income for personal tracking and compliance. If you’re using the property for business, document the business activity by keeping copies of meeting minutes or retreat agendas, attendee lists, etc.
Using the Augusta Rule: an example
Let’s consider a fictional example to see how leveraging the Augusta Rule might work for you.
Dr. Jones, a physician and co-owner of a multi-specialty clinic, owns a spacious lake house in a popular resort area near the city. Recognizing the potential of the Augusta Rule, she decides to strategically rent out her lake house for the clinic’s quarterly partner retreats.
Dr. Jones’s lake house is a well-furnished, five-bedroom home with a large dining room that can be used as the conference room and amenities suitable for high-end retreats. Dr. Jones confirms that local zoning regulations allow for short-term rentals, and the homeowners’ association has no restrictions against this practice.
The property is rented out for two days each quarter, totaling eight days per year. The clinic’s partners and key management staff attend each event, which focuses on strategic planning and relaxation.
Dr. Jones sets up a formal rental agreement with the clinic to rent the lake house. The agreed rental rate is $2,000 per day, reflecting the market rate for such properties during peak times. Dr. Jones maintains all rental agreements, receipts, income records, and meeting agendas to provide clear documentation in case of an IRS audit.
By renting the property for $4,000 per event, Dr. Jones generates $16,000 annually from these retreats.
Under the Augusta Rule, since the property is rented out for less than 14 days per year, Dr. Jones does not have to pay taxes on this $16,000 on her federal income tax return. While the business can deduct the rental payments as an ordinary and necessary business expense, the rental income is completely tax-free for Dr. Jones.
Get professional guidance for any tax strategy.
The Augusta Rule provides an exceptional opportunity for physicians and medical business owners to reduce their taxable income.
Renting out your property for up to 14 days a year can generate substantial tax-free income. However, it’s important to plan carefully and comply with local laws.
If you have questions about whether your property qualifies or how to document the transaction, consult a tax professional. They can help you optimize your tax savings and strategically use your real estate assets.
Alexis E. Gallati is a tax strategist.
June 3, 2024 Kevin 0
…
June 3, 2024 Kevin 0
…
