Renting Residential Property – Tax Free Rental Income

One tax strategy that may not be as well-known is the ability to rent out your personal residence without recognizing the income. Otherwise known as the “Augusta Rule” or “Masters Exemption,” this provision allows you to rent out your personal residence without having to report the income on your personal tax return. This was written into the tax code under Section 280A resulting from homeowners of Augusta, Georgia wanting to rent out their homes to travelers who were in town for the Masters in the 1970s. Fortunately, this rule now extends to all homeowners in the U.S.

If you live near a venue or in a town hosting a big event, you are able to rent out your home for up to 14 days within a tax year, and the rental income would be excluded from taxable income on your personal tax return. The 14-day rule is cumulative and does not have to be taken consecutively. If you rent out your home for 15 or more days, you would need to recognize the income for that tax year, as the IRS would then deem you a landlord.

The biggest opportunity in utilizing this tax savings strategy is for homeowners who are also business owners. The business owner could lease his/her home to the business, which would generate rent expense on the business, and the business owner would not have to recognize the rental income personally. This follows the same 14-day limitation, meaning if rented for 15 or more days, then the rental income would need to be recognized on the business owners personal tax return for that year.

In either case, the rental price must be reasonable and reflect the fair market value or “going rate” for a similar property at that time. For example, if you lived in Arlington, TX near AT&T Stadium, you may rent your home for $150/night on an average night; however, on gameday weekends, you may rent your home for $500/night.  As long as your rent prices are comparable to the market at that time, it should meet the qualifying requirements under this exemption.

You will need to keep adequate records of when and for how much the residence was rented to prove it was rented for a fair price and for 14 days or less in any given tax year. If rental expense is being taken on business return for renting the owners home, the business owner should document why the home was rented to the business and who was in attendance for the business’s rent expense to be justified. Keeping corporate minutes, or what was discussed in the meeting, as well as invoicing your business for services rendered would only further legitimize your business expense.

Examples of business events or meetings are board meetings, shareholder meetings, tax planning meetings, strategic planning meetings, or a company party, just to name a few. Similar to how you would rent out a space to host an event in which the rental price assessed would include the use of tables, chairs, Wi-Fi, or even food and drinks for a company-wide party, the all-in cost including any additional services would be added to the rental price, given the amount of space available and number of people attending. The business would need to be a separate entity with employees and/or current clients. It would be difficult for a sole proprietor with no employees or clients to justify this business deduction (i.e., you cannot rent your home to yourself).

As always, when dealing with tax planning matters, we advise seeking professional advice from a CPA or tax advisor to help ensure you are taking advantage of all tax savings opportunities while also abiding by the tax code.