Augusta Rule: Stay at the Mom and Dad Hotel

With the Augusta Rule, imagine this:

Tax deduction for you
Tax-free income for Mom and Dad

It doesn’t have to be Mom and Dad. The tax-free income can go to your brother or sister, or your best friend.

To make this work, you need to have a business reason to travel and stay overnight at the Mom and Dad Hotel.

Say you travel to a convention, rent your parents’ guest room for five days, and pay them $1,000 fair rent. You deduct the $1,000 as a business travel expense. Your parents have $1,000 of tax-free income.

Sound good? Great—let’s see how you can make this work for you by following three rules.

Augusta Rule Rule 1: 14-Day Limit on Renting

Mom and Dad can rent out a room in their home or rent their entire house (tax-free) if they rent it out for no more than 14 days during the year.

While the rules are generous in allowing your parents not to include this rental income as taxable income, they can’t offset that income with expenses associated with the rental.

If you’re staying with a friend who has an apartment, no problem; he or she can rent out a room in his or her apartment—it doesn’t have to be a privately owned home.

If you’re renting from a friend who shares a place with a roommate, the free-rent rule refers to a “dwelling unit.” So if your friend and roommate both decide to rent out their rooms during the year, they can do it tax-free for a combined total of only 14 days.

Augusta Rule Rule 2: More Than 14-Day Personal Use Requirement

To obtain any tax-free rent, Mom and Dad must personally use the place they rent to you for more than 14 days during the year.

For a primary residence, this isn’t a problem.

But for second homes or vacation homes, your rental from Mom and Dad or your brothers and sisters creates potential trouble. Why? Because the days of your rental (at fair value or not) count as days of personal use for Mom or Dad and for your brothers or sisters.

Augusta Rule Rule 3: Fair Market Rental Rate

When you stay at a commercial hotel, you pay an established commercial rate. So when you stay with Mom and Dad, other family, or friends, you also need to pay a commercial rate, which the IRS refers to as a fair market rental rate for the Augusta Rule.

The fair market rental price is the amount of rent someone who is not related to the renter would be willing to pay. Search for rentals in the area, and print a few comparable listings to substantiate the rental rate you are paying Mom and Dad.

Form 1099

Tax law says that when you pay business rents that exceed $600 to an individual during a tax year, you must report the total of those business rents to the IRS. Hence, if you pay Mom and Dad more than $600 in rent during any calendar year, you have to give them (and the IRS) a Form 1099.

Example. Say that during the year you stay at Mom and Dad’s home for 11 nights while visiting on business. Based on the evidence, you can prove that Mom and Dad’s guest room is about equal to the motel down the street that rents for $119 a night. If you pay Mom and Dad $119 a night for 11 nights, you may deduct the $1,309 you paid for lodging.

Augusta Rule on Mom and Dad’s Tax Return

As a good son or daughter, and as required by IRS regulations, you completed a Form 1099-MISC that told Mom and Dad and the IRS that you paid $1,309 in rent.

Now that you have completed and filed the required 1099, IRS computers are looking for that rent amount on Mom and Dad’s tax return. Don’t let Mom and Dad disappoint the IRS.

Also, keep this in mind: the IRS does not know that the rent is tax-free until it sees the tax return.

Mom and Dad should report the rental income from Form 1099 on their Schedule E for the year.

Then, because the amount is not taxable, they should subtract that amount in the expense section of Schedule E and add a supporting statement such as the following:

Taxpayers rented their personal residence for fewer than 15 days during the taxable year. The rental income was reported on a 1099 and is thus reported as income on Schedule E. That rent is exempt from taxation under IRC Section 280A(g) and is thus removed with the offsetting expense entry on that same Schedule E.

Sales and/or Occupancy Taxes

All the rules above apply for federal income tax purposes. But there’s a tax collector other than the income tax guy who also has an interest in short-term occupancy. This tax collector specializes in occupancy and sales taxes on hotels, short-term rentals of beach and ski properties, and transient lodgings such as that arranged by Airbnb, Homeaway, and VRBO.

You might think that the local jurisdiction is unlikely to know Mom and Dad are renting out their home for a few days to a family member. We prefer to think of the occupancy tax this way: paying the occupancy tax adds to proof of the room’s rental.

Because you get the business deduction for your travel, you should have Mom or Dad or another host add the occupancy tax to your lodging bill. Mom and Dad will pay the tax collector but get no deduction for it because the income is tax-free.

Takeaways

If your business travel takes you to where friends or family live and you would stay with them for free, change tactics and rent their guest room. As you now know, you can do this. You deduct your business travel lodging, and your friends and family can receive the rent as tax-free income.

Remember the three easy rules:

Rent for fewer than 15 days. To qualify for the tax-free rental income, the home must be rented for fewer than 15 days during the year.

Use the property as a home for more than 14 days a year. The home must be used by the owner as a residence for more than 14 days for it to qualify as a residence eligible for the tax-free rent.

Charge fair market rent. Make sure your family or friends document that the rent paid is fair market rent.

Fair rent is the rental rate usual for the area, time of year, and type of place. When you pay related parties, the IRS has fair rent top of mind in its list of questions.

The 1099 paperwork is easy. Do it. The occupancy tax, if any, may prove more difficult, but it does add proof of the rental, and the proof is valuable when having discussions with the IRS about tax deductions.

If you want to discuss this strategy, please give me a call on my direct line at 509-543-7600 or send a request HERE.

March 2022

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