A Tax-Free Windfall Courtesy of Your Home

With all the major sports and cultural events, even conventions, hosted in city and rural areas across the country, there is an opportunity for homeowners to earn tax-free rental income for a brief period when accommodations are in high demand. The Internal Revenue Code has a special provision (§ 280A(g)), allowing taxpayers to rent their personal residences and not pay income tax on that income, provided certain rules are followed. What is the name of this tax perk, you ask? It is the Augusta Rule. Yes, named for the residents of Augusta, Georgia, who would rent out their homes during the Masters Golf Tournament. The tax-free benefit of their rental income was passed into law by Congress in 1976.

So, how does a taxpayer score a hole-in-one and not pay income tax for this rental income?

The Augusta Rule applies only to your primary residence and possibly a vacation/secondary dwelling, but not to a full-time rental or investment property. Additionally, there is no need to fully move out of your home, as renting a room also qualifies.

With your primary residence, the rental period simply needs to be less than 15 days with fair market rent.

For a second qualifying dwelling, think condo, pool house, boat, floating home, RV, or van, provided the structure contains a sleeping space, bathroom and cooking facilities. The rental period must be less than 15 days, charged at fair market rent but the dwelling must also be considered a personal residence. This means you must have used it for at least 14 days during the year.

Since the rental income is not recognized, the related expenses during the rental period (cleaning, utilities, homeowner’s association dues, insurance, etc.) are not deductible. However, property taxes and qualified mortgage interest are deductible, as usual, like the property was never rented, subject to any regular limitations.

The Tax-Free Scenarios:

• Primary residence – Chip and Birdie, a married couple, own and live full-time in their personal residence near a popular golf course and want to rent this home during the annual celebrity tournament. They accomplish this by charging fair market rent for no more than 14 days during the year. The income received is not taxed and they cannot deduct any expenses except for qualified mortgage interest and property taxes claimed as itemized deductions on Schedule A.
• Vacation home or other dwelling – Chip and Birdie also own a qualifying dwelling which they used for 35 days throughout the year. This time, it is the annual music festival. They want to capitalize on the Augusta Rule, and they rented their dwelling for 14 days at fair market rent. In this situation, they qualify because Chip and Birdie used the dwelling for more than 14 days and the rental period was less than 15 days. Again, no income recognition and no expense deductions allowed except for qualified mortgage interest and property taxes.

Because the exclusion applies separately, and annually, to each qualifying dwelling, Chip and Birdie are not limited to one exclusion. If Chip and Birdie follow the rules, they can exclude the rental income on both dwellings.

Easy, right? While this sounds simple, smart taxpayers want to avoid the rough and ensure they are on par with the IRS by maintaining proper documentation to avoid an adverse audit result, especially since the IRS is not known for giving mulligans in this area of tax law.

Suggested Documentation:

• A legitimate rental or lease agreement
• Research on market rent, as the IRS requires rent to be reasonable for the area, the accommodation being rented and the time of year
• A schedule of rental days

In this context, the IRS is primarily concerned with the number of days rented, and less so with the amount of rent received, which is the power behind this opportunity. Depending on the area you reside in, this could be a sizable amount of income received tax-free.

While this article does not explore these opportunities in detail, the Augusta Rule applies to other situations besides special events. For example, homeowners can rent their dwelling for media production. In addition, this can also be an excellent tax planning opportunity for business owners to generate a rental expense deduction for business meetings and tax-free income for themselves.

While the Augusta Rule has been around for 50 years, taxpayers can still end up in a bunker if the IRS audits. Contacting the ASL Real Estate Group can help ensure you end up on the green by implementing this tax perk correctly and defensibly.

About the Author

Related Services

Related Industries