Understanding the Internal Revenue Code’s “Augusta Rule”

Understanding the Internal Revenue Code's "Augusta Rule"

This article explains the "Augusta Rule" under § 280A(g) of the Internal Revenue Code, including how to qualify, common pitfalls for S corporations, and best practices for documenting use to mitigate noncompliance risks. 

What Is the Augusta Rule?

The "Augusta Rule," codified in § 280A(g) of the Internal Revenue Code, explains that if a dwelling unit is used as a residence and rented for up to 14 days, the owner can exclude that rental income from their taxable income. The rule is commonly used for short, event-driven rentals and applies to a house, apartment, condominium, mobile home, boat, or similar property that provides basic living accommodations.

Important Requirements

The IRS and courts focus on several key requirements for applying § 280A(g), including: (1) the property must be a dwelling unit used by the taxpayer as a residence during the year; (2) the total rental period must not exceed 14 days; and (3) no rental deductions are allowed for those days. Further, charging a fair rental price is crucial to avoid having the use recharacterized as personal. A fair rental price is determined by comparing the rent to that of similar properties in the area, considering factors such as use, size, condition, furnishings, and location. A day is generally treated as a rental day only when the property is actually rented at a fair rental price. Thus, days merely available but not rented are not rental-use days. If the property is used both personally and for rental, the rules for dividing expenses and determining whether the property is treated as a home apply.

How S Corporations Get Into Trouble

Where we see S Corporation shareholders get into trouble is when the shareholder tries to use the Augusta Rule by leasing his or her personal residence to the S Corporation. Even though § 280A(g) excludes the shareholder-lessor's rental income if the Augusta Rule is satisfied, the S corporation's deduction must still satisfy § 162's "ordinary and necessary" standard, including reasonableness in amount, a standard applied with particular scrutiny in related-party transactions. 

In the Tax Court's Sinopoli v. Commissioner decision, an S corporation paid shareholders nearly $291,000 in less than three years to "rent" portions of their homes for monthly meetings. Most of the deduction was disallowed due to a lack of substantiation and unreasonableness compared to local market rates. Specifically, the IRS agent identified comparable meeting space locally for approximately $500 per day, far below the amounts the S corporation paid to shareholders. The court found no credible documentation, such as minutes, agendas, calendars, or consistent records, to substantiate the claimed frequency and business purpose of the meetings and allowed only $500 per substantiated meeting. The court emphasized that taxpayers cannot use § 280A(g) as a "tax savings scheme" to distribute corporate earnings by inflating related-party rent. Reasonableness caps the deduction. The result was a reduction in the allowable rent deduction to $500 per substantiated meeting and a total disallowance for meetings that were not substantiated. Even then, the court deemed $500 per meeting "generous."

The Sinopoli case also illustrates three recurring pitfalls for S corporations utilizing the Augusta Rule: (1) unreasonably high related-party rent relative to market comparables; (2) inconsistent reporting of rent income by shareholder-lessors; and (3) inadequate records of the alleged business meetings. 

Documentation to Support Compliance

To align with § 280A(g), maintain clear evidence of the number of rental days (not to exceed 14), along with rental agreements specifying dates, space used, and a fair market value rate grounded in local market data. IRS Publication 527's fair rental price framework suggests documenting comparables considering purpose, size, condition, furnishings, and location. To substantiate the rate, retain third-party quotes or listings.

Regarding § 162, the expense must be "ordinary, necessary, and reasonable." Substantiate the business purpose and occurrence of each meeting with agendas, calendars, minutes, and attendance logs. Where possible, include supporting materials demonstrating the business conducted. The absence of these records can be a major factor for disallowance.

Practical Applications and Risk Management

For business owners considering using a personal residence for occasional corporate meetings, the Augusta Rule can be beneficial when applied correctly, but it is not a license to set arbitrary rent or bypass the substantiation rules applicable to business expenses. The S corporation's deduction remains subject to § 162, which requires ordinary, necessary, and reasonable expenses, and the IRS and courts apply heightened skepticism to related-party transactions.

From a compliance perspective, it is critical to align the number of meetings with actual business needs, maintain a clear paper trail for each meeting, and consistently apply market-supported rates for the space used and time actually consumed. Failure to do so invites disallowance and potential recharacterization, as illustrated in Sinopoli. As always, consult your tax advisors to ensure proper procedures and documentation are put in place before utilizing this tax benefit.