I came across the Augusta rule recently.
This is Code section 280A(g), the tax provision that
allows one to rent their home for less than 15 days per year without paying tax
on the income. It got its name from the famous Augusta National Golf Club in
Georgia. There would not be sufficient housing during the Masters without
participation by local homeowners. The section has been with us since the
1970s.
There are requirements, of course:
(1) The property must be in the U.S.
(2) The property needs to be a residence. Mind
you, it does not need to be your primary residence. It can be a second home. Or
a third home, if you are so fortunate.
(3) The house cannot be a place of business.
a. The
Augusta rule does not work well with an office-in-home, for example.
(4) Rental expenses (excluding expenses such as
mortgage interest and taxes which are deductible irrespective of any rental)
become nondeductible.
(5) A proprietorship (or disregarded single-member
LLC) does not qualify. Mind you, a corporation you wholly own will qualify, but
your proprietorship will not.
a. Another
way to say this is that both the rental income and expense cannot show up on
the same tax return.
(6) The rent must be reasonable.
(7) There must be a business purpose for the rental.
Tax advisors long ago realized that they could
leverage the Augusta rule if the homeowner also owned a business. How? Have the
business rent the house from the homeowner for less than 15 days over a rolling
12-month period.
Can it work?
Sure.
Will the IRS challenge it?
Let’s look at a recent case to see a common IRS challenge
to Augusta-rule rentals.
Two anesthesiologists and an orthopedic representative
owned Planet LA, LLC (Planet). Planet in turn owned several Planet Fitness franchises
in Louisiana. It opened its first one in 2013 and was up to five by 2017 when
it sold all its franchises.
The three shareholders had issues with regular
business meetings because of work schedules and distance. Beginning in 2015
they decided to have regular meetings at their residences. Planet would pay
rent (of course), which varied in amount until it eventually settled on $3,000
per month to each shareholder.
One of the advantages of having three shareholders was
being able to apply the Augusta rule to three houses. If you think about it,
this allowed Planet to have up to 42 meetings annually without voiding the day
count for any one residence.
Let’s do some quick math.
$3,000 x 3 shareholders x 14 meetings = $126,000
Planet could deduct up to $126,000 and the shareholders
would report no rental income.
Sweet.
The IRS wanted to look at this.
Of course.
The first IRS challenge: show us agendas and notes for
each meeting.
Here is the Court:
Petitioners failed to produce any credible evidence of what business was conducted at such meetings, and their testimony was vague and unconvincing regarding the meetings.”
Oh, oh.
The second challenge: the revenue agent researched
local rental rates for meeting space. He determined that one could rent space accommodating
up to 1,200 people for $500 per day.
The shareholders could not prove otherwise.
Here is the Court:
While petitioners argue that the $500 rent determined by … was not reasonable, we disagree and find to the contrary that $500 allowed per month is actually generous.”
This was almost too easy for the IRS.
· Prove
the number of meetings.
· Multiply
that number by $500.
The IRS allowed Planet rent deductions as follows:
2017 none, as no meetings were proven
2018 12 meetings times $500 = $6,000
2019 9 meetings times $500 = $4,500
The shareholders had deducted $290,900 over three
years.
The IRS allowed $10,500.
Yep, that is an IRS adjustment of over $280 grand over
three years, with minimal effort by the IRS.
And that is how the IRS goes after the Augusta rule in
a self-rental context.
The takeaway?
The Augusta rule can work, but you want to document
and substantiate everything.
You want to have agendas for every meeting, perhaps followed up with minutes of the same.
Be careful (and reasonable) with the rental rate. This is not VRBO. You are renting a portion of a house, not the full house. You are renting for a portion of a day, not for days or weeks. You cannot just look up weekly house rentals online and divide them by seven. Those rental rates are for a different use and not necessarily comparable to business use of the residence.
You may want to formally invoice the business.
You want to pay the rent from the business bank account.
Our case this time was Sinopoli et al v
Commissioner, T.C. Memo 2023-105.
