The darling of TikTok tax (as well as blogs by quasi professionals and true tax professionals alike) has recently been the Augusta Rule. In this blog, we’re going to look at what the heck the Augusta Rule actually is, who it helps, how to legally take advantage of it and what potential pitfalls you need to watch out for.
Let’s start with what it is.
The Augusta Rule… The Tax Rule That Started on a Golf Course in Georgia
The Augusta Rule refers to a specific part of IRS Code Section 280A. This Code Section discusses renting out our primary residence or using part of it for business purposes. The “Augusta Rule” has its basis in the golf tournaments that are played in Augusta, Georgia.
People flock to the city to watch and/or participate in the tournaments. Locals realize that this is a way to make some money and so they rent out their houses for top dollar. And, low and behold, the savvy Georgia tax professionals found a tax loophole.
But you don’t have to rent to golfers or golf fans to use it. And you don’t have to live in Georgia. Still, the name stuck.
And thus we have the Augusta Rule.
There is a part of IRS Code Section 280A that allows homeowners to rent out their primary residence for no more than 14 days per calendar year without reporting the rental income on their individual tax returns.
There are a couple of significant parts to that rule. First, 14 days per year. If you rent it for 15 days or more, it’s ALL taxable.
You do NOT need to report the rental income. It doesn’t have anything to do with deductions. It is tax free income.
You could rent out your property for up to 14 days with AirBnB and not have to report the rental income.
The TikTok strategy, though, has to do with using your business and get a tax-free benefit.
Augusta Rule If You Have a Business
If you have a business in the right structure, you can take advantage of the Augusta Rule to take advantage of the tax-free income.
Let’s look at the steps involved with that:
- You must have a legitimate business. That means you could pass the 9 Factor IRS test. Without a business, you can’t take a business deduction. This is a critical first step.
Not sure if you have a legitimate business in the eyes of the IRS?
- Your business must be in an S Corporation, C Corporation, or partnership. If you have an LLC, it must be taxed as one of those three. You cannot use a Sole Proprietorship, Schedule C, or LLC taxed like a Sole Proprietorship.
The corporations and partnership will file their own tax return. The expense for use of the house will be shown as a meeting expense. In the case of a Sole Proprietorship, the individual owner’s return shows the deduction. You can’t show a deduction on one side and not show the income on the other.
- There must be a true business purpose for the rental of the property for the 14 days or less. Some possible ideas would be a business meeting, mastermind, video or audio work or other legitimate business use that your business could have.
- Keep proof that this was a true business relationship. There should be a rental contract and/or an invoice. Charge a fair market value for what another company would have charged for a similar rental. Keep photos and/or emails regarding the meeting. Note the rental of the space in the business’s annual minutes.
- If the rent is $600 or more in total for the year, issue a Form 1099-MISC from the business to yourself for rent paid.
The Devil is in the Details
Now, let’s talk about some of the details that might trip you up.
Quite likely you’re going to receive a Form 1099-MISC. But you’re not the only one who is getting it. So is the IRS and your home state. That means they’re going to be looking for a Schedule E reporting the rental income.
But, as we’ve already learned, the income is not reportable. What now? If you leave it off, the IRS is sure to send you a love note about it. (i.e., a request for more information or maybe just throw you into a full-blown audit)
We recommend reporting the income so that it matches the Form 1099-MISC, but then reducing it with a footnote that explains it is not taxable due to… (and then cite the actual IRS tax code.
If you don’t receive a Form 1099-MISC because the amount received is under $600, you don’t need to file. But don’t skip preparing the Form 1099 if it’s required for your business.
The IRS will disallow expenses that are paid to contractors or rent if you were supposed to prepare a Form 1099 and didn’t send one.
What if You Already Have a Home Office Deduction?
The same code section, Code 280A, talks about the home office deduction. If you have a corporation (either an S Corporation or C Corporation), you have an issue if you pay home office rent to an employee. That is also true if you are an employee/shareholder. The business can take a deduction for the rental payment, but as an employee, you can’t offset any expenses against the income.
That means the home office rent is deductible for the business but it’s income for you. You also would have an issue if you took advantage of the Augusta Rule for 14 days or less. That’s because you now have more than 14 days of rent. The total amount is now taxable.
The Beauty of the Accountable Plan
There is another solution for the home office deduction. If you are an employee/shareholder in a corporation, you can’t take deductions if you receive rent.
instead, set up and run an accountable plan. This allows the business to reimburse the employee or employee/shareholder for home office expenses. There is no income reportable. Just tax-free repayment of expenses. Deduction for the corporation and tax free to the owner.
It also means there is no additional rental income, so your Augusta rule is still in place.
Here is some more detailed information on take a home office deduction if you have various business structure:
When and Where Should You Take a Home Office Deduction
Does the Augusta Rule Work?
Yes, it works. But you have to have the right business structure, a business purpose and follow the paperwork requirements. Plus, make sure your tax preparer is familiar with the write-off so you report it in a way that reduces your chance of audit.
One of the things I strive for in Wednesday Coaching (held 1st – 4th Wednesday of the month at 5 pm Pacific) is that we not only tell you the strategy, but we give you the step-by-step guidance you need to put the strategy in place. And then I’m around almost every week if you have a question about it. (No session on the 5th Wednesday of the month, in the 4 months that have 5 Wednesdays.)