Rich Americans are using the Augusta Rule to generate tax-free income for themselves — can you use it too?

How does the Augusta Rule work?

The Augusta Rule refers to Internal Revenue Code Section 280(A), which allows owners to rent out their property for 14 days or less in a year without reporting the income they earn. Since the income isn't reported, no taxes are due on it. If the number of days goes above the limit, all rental earnings become taxable.

Owners of properties located where the Masters Tournament was played benefited from this rule as they could rent out their homes for large sums during the tournament without being taxed on the income they earned. Anyone who lives in an area where there's temporarily a very high demand for short-term rentals can do the same.

One can also rent out their personal property to their own business, as Wilbratte did, as long as it's used for true business purposes. In this situation, there are two benefits — the company can claim a deduction for the rent paid while the owner who puts the rental income into their bank account doesn't have to report or pay taxes on the money earned.

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The rules of the Augusta Rule

While the Augusta Rule offers a great opportunity to save, you can't take advantage of it unless you can meet specific requirements and follow the rules, like charging a reasonable rental rate. The Wall Street Journal reported on a case of business owners who rented out their homes for meetings and charged their company much more than the going rate in the area. They did not keep good records either. A judge called their actions a “tax-savings scheme” and reduced the amount of total rent they could deduct from $290,900 to $16,500.

Some other rules are that the property cannot be a primary place of business, there must be eating, sleeping and toilet facilities, there must be a legitimate business reason for your company to rent the property, and proper documentation must be maintained.

Wilbratte indicated he used his property to host an event for his staff and clients before Austin City Limits because of its close proximity to Zilker Park, and he made certain to follow these rules.

"Because event spaces are in such high demand during ACL, we called around to document what the going rate was for spaces on the date we hosted our event, which was $1000," he said. "We documented that the event actually happened through a sign-in sheet. We also generated an invoice for our bookkeeping and then paid the invoice directly from the business."

The Berkshire Eagle also reported on Amy, a cosmetics store owner living in Great Barrington, renting her cabin in Lake George, N.Y. to her own business and earning $14,000 annually tax free this way. According to the article, “Seven times a year, she lets some of her employees take the cabin for a weekend for team-building exercises and a Zoom-free 48 hours to focus on important projects. That’s 14 days of tax savings and productivity.”

Can anyone take advantage of this special tax rule?

The good news is, Internal Revenue Code Section 280(A) applies to all property owners of all tax brackets. If you have a tenant for 14 days or less and earn rental income from them, you don't have to report the money you earn.

The bad news is, not everyone can earn a good amount of money from a short-term rental. Business owners can do this if their company has a need to rent their private space. So can people who rent their homes to strangers if their property is in a location where there's high demand for a limited time.

Most people don't find themselves in this situation, though. Those that do also must make sure to follow the rules so their efforts to save don't lead to a bigger IRS bill -- and penalties -- later on.