The ‘Masters Exemption’ (also known as the Augusta Exemption or Augusta Rule) allows startup founders to rent their homes to their startups - for legitimate businesses purposes only - for short periods and reap tax benefits. However, the rules are stringent, and you must take specific steps to stay compliant with IRS regulations. We don’t encourage our VC-backed clients to use the Masters Exemption - why spend your time figuring out how to get cutesy with the tax code when you should be running your business?
At Kruze, we serve VC-backed startups. These are Delaware C-Corporations that receive outside, professional financing and that usually have a well run board of directors. Small business owners who have pass-through entities will have different considerations when it comes to tax strategies. While we always think that businesses and their founders should seek tax guidance from personal tax CPAs, pass-through entity owners have even more complicated taxes and must for sure talk to a qualified tax professional (not us, we work with DE C-Corps!).
In this guide, we’ll focus on how to leverage the Masters Exemption for offsite business events.
What is the ‘Masters Exemption’?
The ‘Masters Exemption’ is based on Section 280A(g) of the U.S. tax code. It enables homeowners to rent out their homes for up to 14 days each year without reporting the income on their federal tax returns. It’s not for business properties, just homes.
Important Clarifications
Ownership vs Renting
Before we proceed, it’s crucial to specify that the Masters Exemption applies only if you own the home you’re renting out to your startup. If you’re renting your residence, this tax strategy isn’t applicable.
Legitimate Business Purposes
The other, important note before we begin: the home must be rented out to your startup for real business reasons. You can’t just decide to try to capture some payroll-tax fee income as a founder, you will need to have a legitimate and necessary meeting or offsite at your house, where actual employees gather and use the space for a true business reason. And you need to document everything, which we’ll get into the steps below.
How to Safely Use the Masters Exemption for Your Startup
So, here are the steps that a VC-backed startup should follow to have one of the founders rent out their home to the company (for legit business purposes) to enable the founder to capture the Section 280A(g) exemption. Pass through entities will have similar steps, but this list is focused on DE C-Corps.
Quick Checklist for Masters Exemption Compliance
- Consult a Tax Advisor
- Before starting, make sure you are going to be compliant
- Talk to both an advisor for your business and one for your personal taxes
- Schedule Legitimate Business Meetings at Home
- Keep the number of days below 15 in a year (14 days max)
- Focus on actual business needs, avoid entertainment purposes
- Document the Meetings
- Have a written agenda
- Take minutes/notes
- Proactively submit them to Kruze / your business CPA
- Determine Rental Pricing
- Research local rates for similar meetings
- Grab screenshots/printouts of similar homes for rent at the same time in the same area at similar rates, and keep this documentation
- Keep pricing reasonable, in line with the other homes you found for rent at similar prices
- Notify and Seek Approval from the Board
- Essential for ethical and financial transparency
- VC-backed startups should have high levels of transparency on payments from the business to the founders
- Not every board will require this, but since the Masters Exemption is transferring money from the company to a founder, we believe that it’s worth letting the board know
- Issue Invoices
- Invoice your business for the rental
- Keep a clean paper trail for both income and business expense
- Payment Protocol
- Have your business pay you through normal business accounts
- Keep records to establish the transaction’s legitimacy
- Issue a 1099
- While on page three of Publication 527, the IRS tells taxpayers not to report the income they earn from these rentals on their tax returns, the business needs a way to claim the expense.
- The business should to issue a 1099 to the founder
- This enables the business to claim the expense
- Critical for IRS compliance
- The founder may need to pay state taxes, which this will enable
- The founder’s personal tax advisor will need to explain to the IRS why/how this 1099 gets excluded from their taxable income.
- Maintain Proper Records
- Keep all invoices, payments, meeting agendas and minutes, and Board approvals on file for future reference
Key Takeaways:
- Rental income for up to 14 days is exempt from federal taxes.
- You must own the home; renters are not eligible for this exemption.
- The 14 rental days can be non-consecutive.
- This impacts the Federal income tax paid by the founder renting out their home
- Many states do NOT have a Masters Exemption, meaning that the founder renting out their home will still have to pay state income tax on the income
- Document everything so you have backup
- Talk to your personal tax CPA as well as your business’
A Brief History of the Masters Exemption under Section 280A(g)
Origins
The so-called “Masters Exemption” refers to a specific provision in the Internal Revenue Code (IRC) under Section 280A(g). Named colloquially after the Masters Golf Tournament in Augusta, Georgia, this rule originated in the 1970s. According to the Tax Foundation, residents of August would take a little vacation during the golf tournament, and rent out their homes to attendees. And they preferred to not pay taxes on the rent they earned. So, they somehow successfully lobbied Congress, and Section 280A(g) was born.
Key Provisions
Under Section 280A(g), a homeowner is allowed to rent their residence for up to 14 days per year without having to report the rental income on their federal tax return. In other words, that income is tax-free. However, because you’re not declaring the income, you’re also not allowed to deduct any rental expenses. The IRS considers this more like a “sharing economy” type of arrangement than a full-fledged rental property business.
Evolution and Scrutiny
The IRS has been increasingly vigilant in ensuring that this exemption is not misused. This is partly why proper documentation and strict adherence to guidelines have become essential. Failure to comply can result in tax audits and penalties, as evidenced by cases like Sinopoli v. Commissioner.
The Sinopoli v. Commissioner Case – A Lesson Founders Renting to Their Business
The case of Sinopoli v. Commissioner serves as a cautionary tale for anyone considering leveraging tax benefits without paying attention to IRS guidelines or careful documentation. In this case, the court ruled against two taxpayers who claimed the Masters tax exemption for rent payments they received from their S corporation. The taxpayers, who were doctors, owned a Planet Fitness franchise together. The franchisee S corporation paid rent to the taxpayers for business meetings that were supposedly held at the taxpayers’ homes.
According to the Wall Street Journal, the business owners took this to the extreme: “The owners said that, for convenience, they decided to hold business meetings in their homes during 2015, 2016 and 2017. For that, the business paid each one about $3,000 a month in rent and deducted total rent of $290,900 over that period, reducing the firm’s taxable earnings. Each owner then claimed the rental income he received from the business was tax-free under the Masters’ exemption. Not so fast, said the Internal Revenue Service. Its agent and lawyers pointed out that the going rate in the area was $500 for a full or half-day rental of much larger spaces. They also said the owners didn’t keep good records—or sometimes any records—of the meetings.”
Needless to say, business owners had to pay a lot!
The decision in Sinopoli v. Commissioner is a reminder that taxpayers should be careful when using the Masters tax exemption. The IRS will closely scrutinize any claims of rental income that appear to be too good to be true. Taxpayers should be prepared to provide documentation to support their claims, such as the documentation we listed out above in the steps on how to claim this exemption.
Conclusion
For startup founders who are also homeowners, the ‘Masters Exemption’ offers a unique opportunity to save on taxes while meeting business needs. But the IRS rules are stringent, and a failure to comply can result in penalties. Make sure to document everything, set a fair rental rate, and consult with tax professionals to maximize this benefit legally. And, for VC-backed startups, really consider if the effort is worth it; you’ll have to coordinate with both your business and personal CPAs, and probably get your board involved, and also document document document. This is yet another reason to work with a unified tax and accounting team like Kruze - we can advise founders like no others on these kinds of tax situations.
