14 Days of Tax-Free Income? Finally, my boat—I mean yacht—can pay for itself!
Ever wonder about those lucky people who get the opportunity to have a film crew use their house? If you are one of those filming lottery winners, you may be severely inconvenienced for a couple of weeks. Members of the cast and crew traipse in and out of your house, mucking things up a bit or a lot. You might even get to use craft services, which is always really good food. Here is the best part: After all those strangers have left and the nasty damages are all repaired, you find yourself in possession of a sizeable payment for rental use of your premises. Other than the bragging rights you receive when you and all the friends you can muster go see the movie, you seize (carpe diem type thing) the opportunity to yell, “That’s my house,” to the entire audience. The best part of that experience is that the sizeable payment from the production accountant is most likely not taxable as income.
“WHAT?” you say. “NOT taxable, that’s not possible!” Obviously, none of you have heard of the “Augusta Rule”. This hidden gem of an exclusion is called so because it is widely believed that the exclusion was created either for the benefit of, or at the behest of, those who live near Augusta Golf Course. So says this Forbes article.
A Bit of Internal Revenue Code – Only for Medicinal Purposes
Section 280A and the Augusta Rule. Congress enacted §280A in the Tax Reform Act of 1976, P.L. 94-455, 90 Stat. 1520, 1569, to address situations where personal use of a residence is mixed with business use. Section 280A does not apply, however, if the business activity is de minimis. Section 280A(g) draws a bright-line de minimis rule at 14 days. That is, if you rent your property out for 14 days or less during the year, §280A(g) says you may not take any deductions. But §280A(g) also says you also do not have to report the income. Thus, income from the rental of your house is not taxable, as long as it is for 14 days or less.
GOT IT!! I can rent my boat to my corporation, tax free.
Great, but I don’t have a boat. Does that matter?
For those of you who own your own business and have to pay a monthly rental fee, you know that fee is deductible as an “Ordinary and Necessary Business Expense” (§162). So, how do I do I rent my house, boat, car, or ADU and not drive my CPA Cuckoo for Cocoa Puffs?
It is not quite as simple as cutting yourself a corporate check, deducting the amount at the corporate level, and ignoring the income at a personal level. First, to be ordinary and necessary the meetings need to be for legitimate purposes. Second, even if the meetings have a legitimate purpose, the rental amount must be ordinary. As I tell all my clients about any deductible expense, substantiation only counts if you end up in front of an IRS auditor. Failure to follow the rules can be very nasty and costly. So then, how do you substantiate the deduction? The real answer is that it depends on the IRS Revenue Agent, their experience, and what they had for breakfast.
You need a written plan. Such a plan demonstrates your intent. The plan should be supported by independent [comparables] within a 100-mile radius. A plan should include a professional appraiser to value the rental rate every three years. In an actual Tax Court Case, Judge Vasquez wrote (in part) “In determining whether the payments in issue are deductible under Section 162, the basic question is whether the payments were in fact rent and not something else disguised as rent. *** Only the portion of an expense that is reasonable qualifies for deduction under Section 162(a).” Not only should you have a plan, but you might want to have a professional review the plan, if for no other purpose, to protect other parts of your return from the auditor.
A last word – Because I wrote this!
In the event you receive a 1099-MISC for renting your home for filming, please do not ignore it. Add the amount to your tax return and make an adjustment referencing the Augusta Rule. This is a great loophole if used properly. Just keep in mind that this loophole can be very tricky and wrought with legal landmines.