The IRS Section 280A aka The Augusta Rule: Loophole for Tax-Free Business Rental Income for your Home
If you are self-employed, you are probably already aware of the home office deduction but you may not be aware of the Section 280a Deduction. The standard home office deduction allows you to write off up to 300 square feet of workspace in your residence at five dollars per square foot for a $1,500 annual deduction. If you use more space than that in your home to run a business, the area method and the number of rooms method can be used to write off a larger portion of your home.
As a business owner, are looking for legal tax deductions to reduce your business’s taxable income liabilities? One strategy is called the “the Augusta Rule” known to the IRS as Section 280A(g), Originally created to protect residents of Augusta, Georgia who would rent out their homes to attendees of the annual Masters golf tournament, the Augusta Rule applies to any taxpayer who owns a home in the United States, provided that your home is not your primary place of business. This section of the tax code allows homeowners in any income bracket to exclude up to 14 days of rental income from their taxable income. This exemption can be a wonderful 2022 tax planning tool, especially for small business owners.
What is the Augusta Rule?
The Augusta Rule lets homeowners rent out their residence to their S-corp, LLC business for up to 14 days per year without needing to report that rental income on their individual tax returns. This rule applies to any taxpayer who owns a home in the United States as long as your home is not your primary place of business. The IRC 280A(g), or the “14 Day Rental Rule”, allows business owners to claim a home rental fee as a business expense. After all, if you weren’t renting the space from yourself, you would be renting it from someone else. Before you get to excited, this tax break is not available to Sole Proprietorships or Single Member LLCs. Consult a tax advisor or accountant to be sure, but most other LLCs, Partnerships, C corps and S corporate structures can take advantage of it. It works for both the business and the business owner/shareholder’s personal taxes by allowing the business to deduct the expense of renting the owner’s personal residence for business purposes. The business/homeowner does not have to report this income on their personal return, tax free money!
Why is it called the Augusta Rule Background?
The Augusta rule IRS exemption was lobbied for by residents of Augusta, Georgia, in the 1970s. Each year, the Master’s golf tournament is held at the Augusta National Golf Club, and residents of the city wanted to rent their homes to attendees of the tournament without becoming full-fledged rental businesses. Their efforts paid off, and Section 280A was added to the tax code. Fortunately, today, the IRS Augusta Rule extends to all homeowners in the US, not just those in Augusta, Georgia.
How Does it Work?
The Augusta rule Section 280A(g) states in part:
“…if a dwelling unit is used during the taxable year by the taxpayer as a residence and such dwelling unit is actually rented for less than 15 days during the taxable year, then… the income derived from such use for the taxable year shall not be included in gross income…”
In layman’s terms, this means short-term rentals of personal residences are not taxable.
Of course, like with all tax laws, there is some fine print worth noting:
- To qualify for the exemption, the taxpayer must be renting out a dwelling unit that they use as a personal residence. This means that renting out a house, apartment, condo, mobile home, boat or similar property may qualify for the exclusion as long as the taxpayer uses that dwelling unit as a residence.
- The Augusta Rule IRS exemption applies to the owner’s primary homes, secondary homes and vacation homes.
- Expenses related to the rental of these properties are not deductible.
- The 14-day restriction is cumulative and does not need to be consecutive. For example, if you live close to a popular wedding venue, you might want to rent your home to guests of different weddings throughout the summer and fall. As long as you do not exceed the 14-day rent rule in a single tax year, you can qualify.
- The rental price must be reasonable for that location on that date. For example, if you live in Los Angeles near the SoFi Stadium, your home may be rented for only $150 per night on an average day. However, in the days leading up to the 2022 Super Bowl, you might be able to charge $500, $700 or even $1,000 per night for the same rental due to the increased demand. As long as your rent prices are comparable to the market, it should qualify for the exemption.
Common Use Example
This may seem like a dishonest loophole, but it’s not. Businesses need meetings. Board meetings, tax planning meetings, shareholder meetings, and strategic planning meetings are just a few of the meetings that are necessary for a legitimate business. In most cases, a business would rent out a meeting room, conference room, or even a ballroom at a hotel. This rental would include charges for the space, state and local taxes, food, drinks, Wi-Fi, and any additional services.
If your business on occasion rents coworking or hotel meeting rooms, conference halls, meeting halls, hotel rooms, catering hall, or other centers for business meetings or gatherings, Section 280A can be a terrific way to take the deduction and pass the tax savings on to one of the business owners by renting their residence for the business purpose.
Another example could be a monthly business meeting of partners or business management for any legitimate business purpose. Instead of renting a commercial hall or meeting place, the business can rent the home of one of the owners or shareholders. This can be for anything from staff meetings to business multi-day retreats. You probably have a lot of the same things at your home: chairs, tables, food, drinks, and Wi-Fi. Why not just put that money in your own pocket, instead of paying a hospitality venue, like a hotel or restaurant?
Compliance Requirement Issues to keep in mind
Shark Tank investor Kevin Oleary’s accounting company Taxhive wrote an article pointing out the compliance requirements for claiming the Section 280a deduction.
The steps and rules for making sure that your use will qualify to include:
- Does your use of the home qualify as an ordinary and necessary business expense?
- Document in writing the purpose of the meeting or business purpose. For corporate entities, there should be minutes recorded with the purpose and conduct of the business meeting or event. This would include the agenda, meeting notes, and attendees.
- You must determine the fair rental amount for the home or area in the home. You can do this by checking the local meeting hall or hotel room rates and recording them in the meeting notes to document for the IRS that the rent is not excessive.
- The paper trail and documentation must include an invoice for the rental. It would clearly set out the rental amount and use of the home for a legitimate business purpose.
- The business should pay with a check for a paper trail. If more than $600 is paid in the tax year, it must be reported on a Form 1099 for the homeowners’ tax return. WAIT, don’t get excited, as this will get reversed!
- The homeowner(s) would report this income on a Schedule E. Then, under the line item for “other deductions,” you would enter the amount reported as income to be offset by a deduction. Describe this deduction as “non-taxable income under IRS Code Section 280A(g).” This negates the income, and the rent is not taxed.
How to Rent Your Home to Your Business and Capture the Section 280a Deduction:
- Schedule Meetings at Your House
- Take Corporate Minutes
- Find Comparables
- Invoice the Business
- Pay the Expense
- Document Income/Expense Write Off
How to Rent Your Home to Your Business with Section 280a
Schedule Meetings at Your House
Anderson Advisors suggests scheduling these meetings on your calendar, and know that you cannot claim more than 14 days worth of meetings at your residence. Note that these meetings cannot be for entertainment purposes.
Keep it on the safe side and only schedule these meetings with current clients and people in the business, not potential clients. Part of the advantage of scheduling these rental days over the course of the tax year is that you can write the charges for these rental services into your income ahead of time, which can help you map out your income plan for the rest of the year, such as trying to avoid a certain tax threshold or reach a certain gross income goal.
Find Comparables for Your 280a deduction
Do your research on Google and find out how much hospitality venues charge for the type of meeting you would be hosting at your home. This will vary from area to area and require a little footwork. It’s often not necessary to call more than one hotel or restaurant and get their rates for events and services; you probably don’t need to do a thorough comparison of several venues. When it comes to buying and selling real estate, we typically recommend pulling a number of comparables, but in this case, it’s a safe bet that if one hotel is charging $1,000 for a one-day conference event, most other hotels in the area are charging a similar rate. Having documentation to support you claiming this as a business deduction is critical to proving the rent was reasonable, you could print rental quotes for similar meeting locations.
Invoice the Business
Create an invoice from you to your business. This invoice should specify all the charges and reflect the numbers indicated by your search for comparables. These invoices will come from you, the property owner renting out your qualified residence, to be paid by your business, the entity renting out the home instead of a typical business meeting venue.
The rental portion of your income will also be tax-free, so these invoices are important to save not only as indicators of operating expenses for your business but also as an indication of tax-free income for personal purposes. Though an invoice can technically be as informal as an email exchange, it is better to use some sort of software or template that creates a standard invoice you can replicate 14 times so that it looks like a legitimate invoice. This method is preferred because it is easy to duplicate and helps prevent any IRS issues when it comes to your 280a deduction.
Pay the Expense
Have the business pay this expense, for example, with a business check. Keep a paper trail to solidify the legitimacy of this transaction.
For example, you might stamp yourself served invoice as PAID, or issue a receipt. This paid expense will get the tax treatment of a business expense on the side of your business, just like any of the other operating expenses your business must shoulder, which are listed as a deduction against its gross income.
Again, you will want to make sure the pricing point of renting out your own personal real estate looks legitimate. An overgenerous amount paid on the side of your business, listed as an operating expense, could also be a red flag, just as much as overpricing your personal residence for tax-free income could look like a red flag on your personal tax return.
Document Income/Expense Write Off
Document this income on your own personal tax form, and write it off on your business taxes.
For most self-employed individuals, that means using Schedule C (Form 1040 or 1040-SR) to write off the rental expense. If you have a different type of business entity formation than the typical LLC or sole proprietorship (such as an S-corp) you may want to talk to your tax advisor.
The dispensation provided by IRC Section 280a deduction is just one of the many beneficial tax breaks the IRS provides to self-employed individuals who own a qualified residence (which also allows you to take advantage of mortgage interest and property tax as write-offs against the income tax).
Unique 2022 Tax Planning Opportunity for the Augusta Rule
Perhaps the most appealing aspect of the Augusta rule is its ability to shift income from a small business. When done correctly, you could rent your home to your small business and receive both a tax deduction at the business level and an exclusion from income at the personal level.
Here’s another example of how it might work:
- You are part owner in a small business. The business rents your vacation home for three days for the management team to use as a planning retreat. During the long weekend, management strategizes about the upcoming year. The business rents your vacation home at market rent.
- The business can deduct the price of the rental as a legitimate business expense. Because you only rented your home for 5 days the entire tax year, you do not need to report that income on your personal income tax return.
- You and the business should keep records that showed the business paid market rent for the rental. You can do this by getting rental quotes from similar locations. You should also keep records that the management team performed business duties while using the rental. They can keep meeting minutes or records that show what strategic decisions were made.
By allowing the business to take a deduction for the rental expense and allowing you to exclude that rental revenue from taxable income, the Augusta rule effectively lets small business owners “double dip” on this benefit. This means that the Augusta rule can be a great tax planning tool for both businesses and business owners.
How Much Rental Expenses Can You Get with a 280a Deduction?
Remember that IRC Section 280a(g) deduction is meant to facilitate a tax benefit for legitimate businesses with legitimate business activity. If a local hotel would charge $1,000 for a one-day rental of a boardroom with drinks and snacks included, you should not rent space from yourself for $4,000.
Likewise, if you are having a business meeting of two individuals at your own residence, you should not use the comparison of a hotel ballroom for a shareholder meeting of 500 individuals.
Use common sense and good old honesty to gauge how much you should deduct, and do your research on comparable venue prices. In some cases, the IRS can actually limit how much you deduct for your home office expenses if you use the area method or number of rooms method, and certainly if you use the standard deduction for a home office, which is 1,500 square feet for the whole year. But there is no limit to what you can deduct in terms of a rental expense, other than what is legitimate and normal.
Can You Deduct Expenses if Your Property is Vacant such as 2nd vacation home?
The article by Anderson Advisors interpretation of the IRS rules suggests that in the wording of the legal language used by the IRS, IRC Section 280a relates to a dwelling unit. And according to the IRS, a dwelling unit “includes a house, apartment, condominium, mobile home, boat, or similar property, and all structures or other property appurtenant to such dwelling unit.” It does not include “that portion of a unit which is used exclusively as a hotel, motel, inn, or similar establishment.” It would seem from the wording of this statement that any property you own can be leveraged for the purpose of professional tax strategies, like renting your own dwelling to your business…even if it’s a vacation home or vacant property.
Keep in mind that the property in question must be something you own personally. If you have it under the umbrella of a business or LLC, you might want to consult with a tax professional.
If you are a small business or startup owner, then the Augusta rule is, without a doubt, a tax exemption you should know about. Bring it up the next time you have a tax planning discussion with your CPA. A CPA Dianna Kennedy wrote a helpful blog about “things to watch out for when using this tax strategy” to make sure it doesn’t raise any issues with the IRS. Feel free to reach out to Huckabee CPA for a free consultation to make sure your use qualifies (to rent your personal residence to your business in an effort to lower your tax burden) and that you document it properly.