Tax Court Says Group Overshot on the Augusta Rule

Under the so-called “Augusta rule,” homeowners can avoid any tax consequences for certain short-term rentals. However, in a new case, Sinopoli, TC Memo 2023-105, 8/14/23, the shareholders of an S corporation got greedy when they claimed six-figure deductions for rent paid to hold business meetings at their homes.

Let’s start with this basic tax premise. If you rent out a main or second home, such as a vacation home, the income from the rental activity is generally taxable. Conversely, you can offset this tax liability with deductions for related expenses, including mortgage interest, property taxes, insurance, repairs, utilities, etc., plus a generous depreciation allowance based on IRS tables. (Some or all of the mortgage interest and property taxes might otherwise be deductible by itemizers.)

In fact, you might even qualify for a deductible loss for the year if your personal use of the home doesn’t exceed the greater of 14 days or 10% of the number of days the home is rented out.

But here’s the kicker. If the rental period lasts 14 days or less—in other words no more than two weeks—you don’t have to report any of the taxable income to the IRS On the other side of the coin, the rental expenses aren’t tax-deductible, either. It’s a non-event as far as the IRS is concerned.

This tax law provision, Section 280A of the tax code, has come to be known as the Augusta rule due to the practice of residents in Augusta, Georgia renting out their homes for high fees during the iconic Masters golf tournament. This approach has been adopted at various other locations around the country where sporting events and performances take place. It’s a good opportunity to pocket tax-free money.

In a variation on the Augusta rule, a group of physicians tried to have their cake and eat it, too. They pocketed tax-free rental payments from their own corporation for use of their homes and then deducted the payments as business expenses. But the Tax Court said they went too far.

Key facts: The physicians formed an S corporation as owners of a Planet Fitness franchise. They claimed it was difficult for them to otherwise meet due to their busy schedules, so they rented out their homes to the S corp, beginning in 2015.

To get an idea of what rent should be charged, the group designated one physician to investigate comparable rental fees in the area. Initially, he settled on a fee of $1.83 dollar per square foot, but the S corporation eventually shifted to flat monthly payments of $3,000. Over the course of three years, the S corporation paid the shareholders $290,000 for reputably holding 36 monthly meetings at their homes. The corporation deducted the rental payments, while the shareholders excluded the income from tax under the Masters rule.

“Not so fast,” said the IRS. It denied deductions for the business expenses for being excessive and unreasonable. Instead, it determined that a $500 monthly fee to be fair under the circumstances.

The Tax Court essentially agreed with the IRS. It pointed out that the shareholders didn’t offer any written documentation such as minutes, agendas or calendars to show that the meetings actually took place. Furthermore, the Court didn’t find the shareholders’ testimony to be credible. In fact, it deemed the figure of $500 per month to be generous under the circumstances. Ultimately, the Tax Court allowed total deductions of $16,500 for 33 meetings spanning three years.

Lesson to be learned: Take what the tax law gives but don’t overstep your bounds. Make sure you’re on firm tax ground.

Taxes