pre-CPE Course

Hyre introduced himself as a tax attorney and accountant who specializes in aggressive but legitimate tax planning for high net worth individuals and small businesses. He explained that he is also a partner in theaugustarule.com, a service designed to help clients comply with Augusta Rule requirements through comprehensive documentation and comparable research. His goal is to balance maximizing tax savings while keeping clients compliant with tax law.

The presentation covered Augusta Rule 1.0, which allows taxpayers to rent their residence to strangers for 14 or fewer days per year with the rental income being completely tax-free. Hyre explained that this rule originated from homeowners near the Augusta golf course who rented their homes during tournaments. The legal foundation comes from Internal Revenue Code Section 280A(g), which states that if a dwelling unit is used as a residence and rented for less than 15 days during the tax year, the income is excluded from gross income, but no rental deductions are allowed.

Hyre detailed the technical requirements for qualifying properties, citing Code Section 280A(g) which defines a dwelling unit as including houses, apartments, condominiums, mobile homes, boats, or similar property with all appurtenant structures. He referenced a proposed Treasury Regulation 1.280A-1(c) that requires basic living accommodations including sleeping facilities, toilet facilities, and cooking facilities. The regulation also clarifies that multiple dwelling units can exist in a single structure, with each qualifying separately for the 14-day rule.

For a dwelling unit to qualify as a residence, Hyre explained that Code Section 280A(d)(1) requires personal use for 14 days or more during the year, or 10% of rental days if greater than 14 days. Personal use is broadly defined under Section 280A(d)(2) and includes any use by the taxpayer, co-owners, family members as defined by Section 267(c)(4), or anyone paying less than fair market rent.

The presentation then shifted to Augusta Rule 2.0, which involves renting to related businesses. Hyre identified several critical issues that arise in these scenarios, including the prohibition against self-rental under Code Section 162(a)(3), the need for legitimate business purposes, avoiding entertainment facility classification, proper documentation requirements, and contemporaneous rental comparables.

Hyre extensively discussed entity structures and their treatment as separate persons for tax purposes. He cited the landmark Moline Properties case from 1943, establishing that C-corporations are separate persons from their owners. He provided detailed analysis of IRS Letter Ruling 2017-47-006 and Technical Advice Memorandum 2002-14007, which confirm that S corporations are also treated as separate persons, even when 100% owned by one individual.

For partnerships and multi-member LLCs, Hyre referenced Treasury Regulation 1.707-1(a), which treats partners acting in capacities other than as partners (such as landlords) as separate persons. He noted that spousal partnerships are recognized but present challenging optics during audits.

The presentation included extensive case law analysis, particularly the Feldman case (84 Tax Court 1), where the court established that related party leases require careful examination but are permissible when properly structured. The court emphasized that excessive rent doesn’t invalidate the entire transaction but only the unreasonable portion. Hyre also discussed the Cox case, which allowed 50% rental deductions for spousal rentals under certain ownership structures.

Hyre analyzed the recent Sinopoli case, a significant Augusta Rule loss where taxpayers failed primarily due to inadequate documentation. The taxpayers charged $3,000 monthly rent but had outdated comparables, no contemporaneous meeting notes for most meetings, and family members present during business meetings. The court allowed only $500 per meeting for the nine meetings that had proper documentation.

Regarding business necessity under Code Section 162, Hyre cited Supreme Court cases Welch v. Helvering and Commissioner v. Tellier, which establish that “necessary” means only “appropriate and helpful” rather than absolutely essential. He provided examples of legitimate business purposes including annual meetings, employee training, client meetings, and fundraising activities.

The presentation addressed entertainment facility restrictions under Code Section 274, identifying boats, yachts, hunting lodges, and fishing camps as per se entertainment facilities where deductions are typically disallowed. Hyre discussed the Ireland case involving a beach house where family entertainment exceeded business use, resulting in disallowed deductions.

Hyre outlined specific documentation requirements including contemporaneous meeting notes, annual rental comparables, actual rent payments, proper lease agreements, and detailed activity records. He emphasized that most Augusta Rule failures result from inadequate substantiation rather than legal deficiencies.

The presentation concluded with best practices recommendations, including minimum four-hour meetings, clear business agendas, preferably non-family attendees, AI-recorded meetings with edited notes, and annual comparable research. Hyre stressed that while the Augusta Rule is legitimate when properly implemented, it requires significant documentation and careful attention to detail.

 00:17

Tik tok, Augusta rule, tik tok. And I wanted to get to the bottom of it. A lot of CPAs and other tax professionals are very skeptical of the Augusta Rule because of what’s been put online and because so much of what’s online is just really not very good. 

 00:34

So I’ve done the research for you in sickening depth. This presentation is really not for the faint of heart. It’s for tax professionals who want to know, does the Augusta Rule work? Is it legitimate? 

 00:47

What are the requirements? How does one comply? And so I’m going to go over it in horrifying detail. Now if you’re a non-tax professional and not really inclined to delve that deeply into these sort of topics, well, fair warning, we are going to go into, as I said, horrific tax detail. 

 01:11

I am a tax attorney and accountant. I don’t have a CPA license. I thought the bar was enough, the law license, and so I decided not to get any other licenses. I’ve been at this for about 30 years. I have a practice that involves planning. 

 01:26

I used to do returns. We sold that practice. I also speak nationally on a number of topics. I tend to speak a lot on self-directed IRAs, self-directed 401Ks, rollover business startups, taxation of real estate, including not just rentals but MIPS, exotic things like subject to or assignments, short-term rentals. 

 01:49

I do a lot with high net worth individuals, small business. We focus really heavily on legitimate, legal, but very aggressive. I really do believe in using the code. to the advantage of the taxpayer whenever it’s gray, and it’s just so very frequently gray. 

 02:07

And so I do believe as long as the client’s okay with it in using that gray for the client to pay less. And consequently, I do read a lot of case law on any number of topics. I’m also a partner in the augustarule.com, the augustarule.com. 

 02:26

And that is a service that makes complying with the August Rule much easier. We do comps, we look for aggressive, but supportable comps. Our goal is twofold, just as in my practice. My goal is to save my clients as much money as possible, but I also want to keep all of us out of trouble. 

 02:44

And so I have to balance those two goals. We’ve done that with theaugustarule.com as well. This material, again, This material is being a little redundant now, but they say, tell them what you’re gonna say, say it, tell them what you said, and that way it tends to stick. 

 03:04

This is highly technical material. I spent a lot of time researching the various nuances of the Augusta Rule, and the real reason was that there’s just so much bad quality content online, and we see clients doing things under the guise of the Augusta Rule that really aren’t correct. 

 03:22

So I wanted to set the record straight. So we are gonna go into the statutes, to the regulations. We’re going to get into the case law, into IRS rulings. It’s going to be granular. The idea is this is a rough draft for a CPE. 

 03:37

We want to provide educational credits to accountants, to enrolled agents, and so forth. This is a rough draft, and I am looking for your feedback. So if there are things you think I could improve, things I think you think I could do better, please let me know, because I want this to really be the definitive source for the Augusta Rule. 

 03:57

The best thing out there on the net where people can turn to and say, ah, this part is legitimate. This part is not legitimate. This is how things should be done. So please do feel free to send feedback. 

 04:11

You can reach me at John Hyre, johnhyre@realestatetaxlaw.com. johnhyre@realestatetaxlaw.com. Or you can just go to theaugustarule.com website and use Contact Us, theaugustarule.com website, and just hit Contact Us, and if you have any feedback to send, we would sure love to hear from you. 

 04:43

We have linked to the cases. As I said, I’m going to cite a lot of cases, regulations, statutes. Here’s the link, and we’ll go ahead and make sure that that’s periodically updated. There will be a lot of cases to link to. 

 04:57

and to save you from having to look them up yourself, we’re going to provide an index that links to the cases, to the statutes, and so on, so you don’t have to take my word for it. You can read these yourself and see if you agree with what I say, if you like or dislike my interpretations of the law. 

 05:15

So Augusta Rule 1.0, this is simple. You rent a residence to a stranger for 14 or fewer days per year. That rent is excluded from income. Easy. So once again, Augusta Rule 1.0, you rent your residence, you can have more than one residence. 

 05:34

Note it’s not necessarily a principal residence, it could be any residence to a stranger, not to a family member, not to your business, just to a perfect stranger, a non-related person for 14 or fewer days per year. 

 05:49

If you do so, it is tax-free. Where do we get the name? because people on the Augusta golf course were renting their homes daily for a few days per year when the tournament was in progress for very high rates. 

 06:04

It was a very well-known thing, and that’s where it got the nickname the Augusta Rule because the usual suspects were outraged that people were renting their posh residences on a golf course and not paying tax on the rent. 

 06:19

Yet when they looked into it, it turned out that it was perfectly legal. So we’re going to go through the Augusta Rule 1.0, which is much simpler than the Augusta Rule 2.0. The Augusta Rule 2.0 is when your business, for example, you have a medical practice, an S corporation, and you’re renting your home to it. 

 06:40

That becomes a lot more complicated. So we’re going to go through Augusta Rule 2.0 after we cover the basics of the 1.0 version. And here’s the founding statute, Internal Revenue Code Section 280A(g). 

 06:58

Now, first thing, when you look at this code section, it starts with notwithstanding any other provision of this section. What does that mean? What I’ve noticed with practitioners is they tend to get tied up in the rest of Code Section 280, Cap A. 

 07:15

But for the Augusta Rule, most of Code Section 280, Cap A, is not relevant. We only pull a few definitions from there in order to breathe life into Section 280, Cap A, g. So this is the actual citation straight from the code. 

 07:32

I will read it, and in the next slide, I will explain in English what it means. Notwithstanding any other provision of this section, it is a very important language. That’s why I highlighted it. Or Section 183, if a dwelling unit is used during the taxable year by the taxpayer, as a residence, and such dwellers. 

 07:54

filing unit is actually rented for less than 15 days during the taxable year, then one, no deduction otherwise allowable under this chapter because of the rental use of such units shall be allowed, and two, the income derived from such use for the taxable year shall not be included in the gross income of such taxpayer under Section 61. 

 08:19

And just to be clear, the emphasis and capitalizations are mine. Let’s go to the next slide where we get into the English, but this is the actual code section because what do we always want to see? The law. 

 08:32

That you read the law. You interpret the law. You decide if you agree or disagree with my interpretation. So in plain English, a taxpayer may rent his home for up to 14 days during the tax year and exclude the rent from income. 

 08:48

In other words, such rental income is tax-free. If the home is rented for more than 14 days per year, then all the rental income is includable in gross income. For example, if it’s rented for 15 days, it’s not that one gets 14 days tax-free and only includes one day. 

 09:07

Rather, it blows the whole provision. 15-day rental means none of the rental income is tax-free. And there is a trade-off. Isn’t there always with the code? The taxpayer cannot deduct any expenses related to that rental activity. 

 09:22

For example, depreciation and utilities. Now, they can still deduct personal expenses with regard to the residence. So, mortgage interest to the extent it would normally be deductible on Schedule A is deductible on Schedule A. 

 09:37

Property taxes to the extent that they’re deductible on Schedule A and subject to the $10,000 cap, etc., etc., remain fully deductible. The point is no rental type deductions such as depreciation, such as maintenance, such as repairs can be deducted. 

 09:55

So, we give the IRS gives, Congress gives the income tax-free, but there’s a trade-off. There are no deductions allowed other than the normal personal deductions that one gets for a personal residence. 

 10:09

It is very important to remember the notwithstanding language. Code Section 280, Cap A, small g stands apart from the rest of Code Section 280, Cap A. That’s very important because, again, I’ve watched practitioners kind of logically start reading Code Section 280, Cap A sequentially starting with Subsection A, then moving to Subsection B, and so on. 

 10:36

That becomes very confusing, and it’s redundant. A great deal of 280, Cap A does not apply to Code Section 280, Cap A, g, so that notwithstanding language is extremely important. Now, we will dig into… 

 10:52

280 Cap A, but only to pull definitions for things like a dwelling unit or a residence. Dwelling unit, this is a direct quote from the code, IRC section 280 Cap A, f, 1, dwelling unit defined. For purposes of this section, the term dwelling unit includes a house, apartment, condominium, mobile home, boat or similar property, and all structures or other property appurtenant to the dwelling unit. 

 11:25

Pretty straightforward, I think. There is a proposed treasury regulation that further defines dwelling unit. Now, this proposed regulation was never made temporary, and it was never made permanent or final, so it’s not actually law. 

 11:41

But what I found in practice is that the IRS and practitioners alike look at this particular proposed regulation for clarity. So it’s not enforceable law, but it does provide clarity. And frankly, I think it provides useful, good clarity. 

 12:00

I don’t think it’s really pro-taxpayer or anti-taxpayer. It really just clarifies. Proposed Treasury Reg 1.280 Cap A-1C provides that a dwelling unit must contain basic living accommodations, a place to sleep, toilet facilities, and cooking facilities. 

 12:20

So when we think about what is a dwelling unit, we ask, is there a place to sleep? Are there toilet facilities? And are there cooking facilities? And it’s within reason. An RV would qualify, a boat would qualify, certainly vacation homes qualify. 

 12:36

We could get a little bit persnickety in trying to make silly arguments that maybe a tent with a can of Sterno and a little burner and a bucket out back for one to take care of their physical necessities would qualify. 

 12:50

Technically, it’s a place to sleep. Technically, there’s a sort of toilet facility, that bucket. And technically, the little burner that is about this big and full of Sterno might actually allow you to cook meals. 

 13:03

That’s probably pushing it a bit much. So as always, within reason. So the regulation, again, was never finalized, but I have seen both in audits, as well as just talking to other practitioners, people often rely on this temporary, I should say, not temporary, that would be better, it would actually be law, this proposed treasury regulation. 

 13:25

Multiple dwelling units, the same regulation goes on. A single structure may contain more than one dwelling unit. For example, each apartment in an apartment building is a separate dwelling unit. Similarly, if the basement of a house contains basic living accommodations, the basement constitutes a separate dwelling unit. 

 13:46

For example, somebody buys a quad, right? So they buy a property, it has four separate apartments for dwelling units. Let’s say the taxpayer stayed in each dwelling unit 14 days of the year, converting it into a residence. 

 14:02

We’ll get into that in a minute. Could each dwelling unit be a residence and you have four separate dwelling units and the 14 days applies to each dwelling unit? Each dwelling unit, there are four of them in a quad. 

 14:17

Each dwelling unit could be rented out for 14 days tax-free. Yeah. Yeah. So let’s say we have a quad, unlikely, but a quad on the Augusta golf course. It’s got a house or building with four separate dwelling units. 

 14:32

Could we make sure to qualify each one as a residence? We’ll get into that in a moment. Rent each one out during the tournament for 14 days and the income on each dwelling unit would be tax-free. Yes. 

 14:47

The proposed treasury reg provides it, and I think just the reading of the statute doesn’t disallow it. Now let’s remember I’m a lawyer. I tend to read statutes such that if something is not clearly prohibited, I think it’s allowed. 

 15:02

People who are very conservative in how they read the code, if there aren’t 20 examples of where it’s explicitly permitted, they tend to say no. That’s not my philosophy. My philosophy, one by the way which has been successful in audits and in court for the last 30 years, is if it’s not explicitly prohibited, then it’s gray. 

 15:23

I think it’s permitted, and I’m going to run with it. That’s my philosophy. You have to decide if it’s your philosophy. But here I think it’s pretty clear multiple dwelling units in a single structure, or for that matter, multiple dwelling units spread out. 

 15:37

I have a camper. I have a vacation home. I have a principal residence. Would all three qualify as a dwelling unit? Yes. Does the Augusta rule apply separately to each of the three? Yes. If you go back and read 280 cap AG, you’re going to see that it talks about a dwelling unit that is a residence, and there’s no limitation on how many dwelling units or how many residences one can have. 

 16:05

I would also note there’s no requirement in the statute that one own the dwelling unit. A dwelling unit here is defined. You’ll see residence shortly defined. Never is there a requirement for it to be owned. 

 16:21

So if I rent an apartment and I reside in it, if the apartment is a dwelling unit, presumably I can sleep there, I can cook there, and I can take care of other necessities there, that is a dwelling unit. 

 16:34

It qualifies under this definition. There’s no requirement for ownership, and I as an attorney will not impute one. I’ve never seen the IRS attempt to do so. So, when is a dwelling unit a residence? If you remember, 280 cap A g requires that we have a dwelling unit that is a residence. 

 16:57

The whole purpose of the larger code section, 280 cap A, is to very broadly define residence. The purpose is that if you have a residence, this is now not g, this is not the Augusta rule we’re talking about, the purpose of the larger statute where we’re drawing our definitions is to prohibit things broadly. 

 17:18

Specifically, section 280 cap A disallows losses on something that is a personal residence. If you rent out a personal residence for more than 14 days a year, 280 cap A disallows those losses and the IRS to disallow in a broad way, defined both dwelling unit and residence in a very, very broad fashion. 

 17:43

But now when we look at the Augusta rule… This very broad definition helps us. It’s very easy for something to qualify as a dwelling unit. That was the purpose. It was very easy for something to qualify as a residence. 

 17:56

That is the purpose. So code section 280-A d 1 says, a taxpayer uses a dwelling unit during the taxable year as a residence. If he uses such unit or portion thereof for personal purposes for a number of days, which exceeds the greater of 14 days or 10% of the number of days during such year for which such unit is rented as a fair rental or at a fair rental rate. 

 18:28

Translation. If you have personal use for 14 days or more, you have personal use. If you have personal use for 14 days or more, you have personal use. Now, B, 10% of the number of days during such a year for which such a unit is rented at a fair rental doesn’t matter for the Augusta Rule. 

 18:48

If you think about it, an Augusta Rule residence, if it’s rented for more than 14 days per year, the Augusta Rule doesn’t work. So if we have a situation where B applies, 10% of the number of days of the total days rented is greater than 14 days of rental. 

 19:06

We no longer really have a residence. It’s technically a residence, but it’s also a rental where way past the 14 days of tax-free rental time, the Augusta Rule wouldn’t apply. So section B here, capital B, is not really relevant. 

 19:23

The bottom line is if we have personal use for 14 or more days during the year, think personal use, 14 days or more per year, then we’ve got ourselves a dwelling that is a residence and it qualifies for the Augusta Rule. 

 19:39

Personal use, as I promised you, is very broadly defined. Section 280 cap A, d 2, and again I’m reading straight from the code, personal use of a unit. For purposes of this section, the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day. 

 20:02

For any part of such a day, the unit is used. So any amount of personal use during the day, any amount, no matter how small, makes the whole day a personal use day. Then the code goes on to list starting with A, the different things that trigger personal use. 

 20:22

But the trigger is a hair trigger. Any use during the day means you’ve got personal use. So A, what’s the first thing that triggers personal use? For personal purposes, buy the taxpayer or any other person who has an interest in such a unit, meaning a co-owner. 

 20:39

Let’s say I co-own with a friend. I have a tenant in common interest with a friend. Any use by… Either of us is personal use and we add up our use as co-owners to get to the 14 days. So for personal purposes by the taxpayer or any other person who has an interest in such unit or by any member of the family as defined by code section 267C4, we’re going to go through that, of the taxpayer or such other persons, 

 21:08

the co-owner. Family use. 267C4, family for purposes of this code section includes spouses, siblings, including half-siblings, ancestors, parents and grandparents being examples, and lineal descendants, children and grandchildren. 

 21:28

For example, you own a vacation condo. Your adult daughter uses it for a week. Her use is the same as your use that counts as personal use. Even if she pays a fee, full fair rental value for the use during the week. 

 21:43

Now there’s an exception to this rule. If she is paying full rental value and uses it as her principal residence, this is where she regularly resides. She’s renting from you long-term, presumably annually, and it is her personal residence that will not count as personal use. 

 22:03

So it’s a little detail, but the bottom line is this. We’ve got family defined up above, and any use by family counts as personal use by you, even if the family is paying full fair market value for that short-term use. 

 22:20

So it’s very easy to qualify for personal use. Home swaps. The next portion of 280A, d,2,b, we just went through A,d,2,b treats as personal use any day when the unit is used by anyone under an arrangement that lets the taxpayer use some other dwelling unit, even if rent is paid. 

 22:44

In other words, a vacation home swap, for example, you own a beach house in Florida, your colleague or someone you’ve never met owns a ski chalet in Colorado, you agree to let each other use each other’s property, they come use your Florida property, you go use their Colorado property, that counts as personal use, home swapping counts as personal use. 

 23:09

IRC section 280A d,2,b also says use by any individual other than an employee with respect to whom code section 119 applies. Unless for any such day, the dwelling unit is rented for a rental, which under the facts and circumstances is fair rental. 

 23:28

That’s a mouthful. This is typical code speak. I’m not going to reread that. Here’s what it really says. Any use for even part of the day, by any individual who is paying less than fair market value rent, any individual. 

 23:44

who is paying less than fair market value rent, if that occurs, it’s considered a personal use day. So, if you want to avoid personal use for some other purposes, for purposes of the larger 280 Cap A purposes, for example, you want to avoid disallowed losses on your rental, you might look at making sure that any rental is documented at fair market value because rental to anyone for less than fair market value is personal use. 

 24:14

Now, for the Augusta rule, that’s a good thing. It makes it very easy to get 14 days of personal use because remember, we have a dwelling unit, it is a residence if there’s 14 days or more of personal use and the gist of these past few slides is it’s really, really easy to trigger personal use, whether it’s you, whether it’s home swapping, whether it’s a family or whether it’s anyone using it and they’re not paying full fair market rental value. 

 24:44

The section 119 exception is not super relevant here. It’s mentioned there. I took a look at it. It has to do with employer providing housing or providing the employer provides housing to an employee for the convenience of the employer. 

 25:00

There’s a bunch of case law on it. There are separate tax reduction techniques that involve using that code section, but here it’s not really relevant because here our goal is to trigger personal use and we don’t really care about exceptions to personal use. 

 25:17

Triggering personal use is extremely easy. The section 119 exception doesn’t really matter to us in that context. So summary of the Augusta Rule 1.0. We have a dwelling which has areas to sleep, it has toilet facilities and it has a kitchen. 

 25:37

Plus we have 14 days of personal use during the year, broadly defined, very easy to trip that hair trigger, you add the two together and that equals a residence. Once we have a residence, note this is not a principal residence, that’s a different term. 

 25:55

Principal residence is important for Code Section 121 when we’re talking about excluding income from the sale of a principal residence. Here we are talking about a residence. You can have multiple residences. 

 26:07

You don’t have to own the property. If we have a residence, there’s 14 days of personal use in a dwelling unit, then 14 days of rent, and no more than that, it can’t be rented for more than that, is excluded from income when we rent to strangers. 

 26:25

That’s the Augusta Rule 1.0. Very simple, very straightforward. Things get more complicated when we move into Augusta Rule 2.0. Ah, here’s where things get a bit more complicated, the Augusta Rule 2.0. 

 26:42

Once you’re renting to a related business, to a related person, the scrutiny level increases dramatically. The IRS takes a closer look. The code allows for this. The case law allows for this. What are some of the issues that arise when we have the Augusta Rule 2.0? 

 27:00

In other words, we have a residence, we have a dwelling unit that was sufficiently used personally to make it into a residence. We want to rent to a business that we own all or part of. The business rents to us, it gets a deduction, but we receive the rental income tax-free and therein lies the trick. 

 27:20

Both sides have to work. Actually receiving the rental income tax-free, what we just covered, is the easy part. The harder part that requires things like documentation and an actual business purpose is getting the deduction for your closely held business. 

 27:39

And so what are some of the issues we run into on Augusta Rule 2.0? One, you cannot rent to yourself and we’re going to have to find yourself. For example, I rent my residence to an S corporation, 100% owned by me. 

 27:54

Is that me renting to me? And by the way, the code says no, the S corporation is a separate person. So it’s okay, we’ll get into that. But number one, you cannot rent to yourself. That’s code section 162A3. 

 28:08

You have to have a true business purpose to get the deduction. Rent is deductible under code section 162, ordinary and necessary business expenses. There has to be a true business purpose. Now the standard’s very low. 

 28:21

For those of you who’ve looked at code section 162 law, the threshold for ordinary and necessary is very low. This is not a hard hurdle to clear. Three, we have to avoid the home being an entertainment facility. 

 28:35

By the way, most of what I see online about the Augusta Rule completely ignores this. It’s a very important point. If the home, if I should say, you’ll use better language, if the residence is considered an entertainment facility, the deduction to the business is disallowed, so we want to avoid that classification. 

 28:56

Four, there has to be actual, meaningful, properly spelled, well-documented events occurring in a business-like fashion. Look, we all know as professionals in the tax industry, most of the cases, most of the examinations that the IRS wins is not because the elements of the deduction were not present. 

 29:18

It’s because the taxpayer did not properly substantiate what they needed to. They couldn’t prove the deduction. They were unable to prove it. They didn’t have the documentation. Therefore, they lose. 

 29:30

So we’re going to get deeply into substantiation. Five, accurate, annual, that’s really important, contemporaneous, and documented rental comparables. the Augusta Rule losses in audits. We hear about them anecdotally. 

 29:46

We’ve seen some case law that we’re going to dig into. Not having good comparables for how much the residents should be rented to your own business for. Not having good comparables that are contemporaneous, well done, well documented, and contemporaneous really does mean doing it at least once a year. 

 30:06

That’s usually how the IRS disallows Augusta Rule 2.0. We want to make sure there’s also a true business purpose for purposes of a fairly new code section, 77-010 and the associated penalty statutes, 662-B6, 662-I. 

 30:26

This is a lack of economic substance. Roughly in 2012, code section 77-010 passed instead of a transaction, lacks economic substance. There are very large penalties. Now that code section, at least as far as the case law is concerned, has lain dormant until recently. 

 30:47

There was a recent case that had to do with captive insurance, commonly referred to as Patel-3, and it actually implemented, was the first time that that 77-010 has been to court, and so the full tax court met and issued a full decision getting into what does it mean to have a lack of economic substance. 

 31:09

And I do think that improperly done, Augusta Rule 2.0, which is very common, if people just follow what they hear on TikTok, would run afoul of the lack of economic substance sections, and the penalties are steep. 

 31:25

It’s a 40% penalty on the deduction if you lack economic substance. In other words, if you simply say you rented and you didn’t actually do anything, or maybe you even, you have a rental of a residence to a business, a related business, and there’s actual rent paid. 

 31:42

but there was no real meeting. Nothing was actually done. There’s a lack of economic substance there. So I think that this Augusta rule on paper where there is no substance to the meetings or to the activity that occurred are very vulnerable under number six for lack of economic substance and the heavy 40% penalties that might follow. 

 32:03

And finally there needs to be proper reporting of both the 1099 issued by the business to the owner of the residence and then it needs to be reported on schedule E as a rental. Now the net income will net out to zero but we need to show gross income equal to the 1099. 

 32:23

So I’m gonna dig into these issues in great horrible detail. Probably more detail than you need but I want the detail to be there so you can fall back on it. Self-rental means no deduction. Section 162A, there shall be allowed as a deduction all the ordinary and necessary, we’re all familiar with the classic language, expenses paid or incurred during the tax year in carrying on any trade or business, 

 32:55

including 162A3, rentals or other payments required to be made as a condition to the continued use or possession for purposes of the trade or business of property to which the taxpayer has not taken or is not taking title or in which he has no equity. 

 33:17

Now before there was case law, this section might have fouled us. If interpreted broadly, for example, my business is an S corporation, it is renting from me. Do I have equity in the S corporation? Do I have equity in the property? 

 33:36

And if the answer were to be yes, then this code section would disallow Augusta Rule 2.0. However, what we’re going to see based on the case law that this is very narrowly construed. Basically, if the taxpayer owns the property personally, I own the rental residence and the business is on a Schedule C. 

 33:59

So I have a Schedule C business, that’s me, and I’m renting property from me, then it’s considered to be, well, wait a minute. Let’s look at the wording. Is it a rental or payment required to be made on a property to which the taxpayer has taken title or in which he has equity? 

 34:19

Well, if the S corporation were considered to be the owner of the property, because remember, the S corp is a separate person. We’ll get into that. There’s plenty of case law on this. The S corporation is not you. 

 34:31

If the S corporation were viewed as having equity in the property, it’s renting. This is common sense. The rental deduction would be disallowed. You can’t rent from your home. yourself. This is most commonly when a taxpayer has a Schedule C business. 

 34:46

They have a Schedule C business, a sole proprietorship, and then they rent a property. They use that business. That business rents a property from the taxpayer. What’s the problem? Well, a Schedule C is you personally. 

 35:00

You personally own the rental property. If the business that is you personally, is renting from you personally, you run afoul of this code section. There’s no deduction allowed. That’s what this code section is getting at. 

 35:14

The problem with this code section read on its own before we look at the case law. Again, there could be an argument made that will wait a minute. An S corporation, for example, that you own 100% of, renting property from you could be renting to itself. 

 35:32

Well, the case law says otherwise. The case law says let’s skip to the, here’s the spoiler alert. S corporations. C-Corporations, LLCs taxed as C-Corporations, LLCs taxed as S-Corporations, partnerships with more than, in other words, LLCs with more than one member or limited partnerships or limited liability partnerships or even general partnerships with more than one member are considered separate people from the owners. 

 36:03

So these entities are not the same person when the S-Corp rents a home from you. The S-Corp is a different person when it’s renting that residence from you and therefore we don’t run afoul of this provision. 

 36:17

Likewise, partnerships, an LLC with more than two members, for example, renting a property from its owners, the LLC is considered to be a separate person and therefore we don’t have a self-rental problem and that’s what this code section gets at. 

 36:35

It’s really saying you can’t have a self-rental but because of the entity structures and the entities such as S-Corp, C-Corp, LLC, LP, general partnership are deemed to be separate persons, they are now renting from you personally a residence. 

 36:54

You personally are a separate person from the entity so this code section becomes in most cases moot. So there was a case, Cox, you’ll see the citation there at the bottom, Cox, a tax court memorandum. 

 37:11

We have the proposition that spousal rentals, which was surprising to me, are sometimes okay. An attorney had a Schedule C practice and he was a tenant in a property owned with his spouse via tenancy by the entirety. 

 37:26

Now, it could have been community ownership, it could have been joint ownership. We probably would have gotten the same result but in some states, there’s a special way to own a personal residence, a tenancy by the entirety. 

 37:40

It is generally favorable because it provides asset protection. So we’ve got spouses. We have an attorney and the spouse. They own a residence via tendency by the entirety. The attorney rented that residence that was owned by the spouse and the attorney to his Schedule C law practice. 

 37:59

And what the court said, you’ve got 50% self-rental. We’re disallowing 50% of the deduction. That’s 50% self-rental. Why? Your spouse is considered to be a separate person from you, at least in the state of Missouri. 

 38:14

Because these cases do look at local law to see if spouses are treated as separate persons. And they look at local law, in this case Missouri, to see how spouses are treated, separate persons or just one person, under tendency by the entirety. 

 38:31

So they were holding the property as tenants in the entirety. That’s a way of holding title. and the court said in Missouri, tendency by the entirety means each spouse is entitled to 50%. Therefore, half the property was owned by the attorney, and because the attorney ran his business through a Schedule C, that was a disallowed self-rental. 

 38:54

But the court also said that half the rental was legit. Half the rental was deemed to be from the spouse to the Schedule C business, and that was two separate people. It was the spouse renting to the attorney for purposes of Code Section 162. 

 39:13

That was fine, is what the court said. So can one rent a property, can one rent a personal residence through a Schedule C business from a spouse? Yes, according to this case. Now, it will vary by state. 

 39:29

I also have to add, it’s really bad optics. You’ll win the case. There’s case law, and as long as in your state, for example, tendency by the entirety is treated as a separate thing, where the spouse is treated as a separate person, then you’ll win the case. 

 39:44

What’s the problem? It just smells fishy to an examiner. An examiner in general is going to have an objection to financial incest, even if it’s legal financial incest. So there is a transaction between the spouses. 

 40:02

She is, in this case, renting a property that she owns 50% of to a Schedule C sole proprietorship. The court said it was legit, but you’re gonna have some convincing to do in an examination. So my point is this, if there’s a different way to structure this, if the attorney’s business were an entity, such as an S-corp or a C-corp, or a partnership, assuming we could find a legitimate other person to be the partner, 

 40:28

then we would be fine. It would be better optics. The IRS is less likely to challenge it and more easily persuade it if they do challenge it, that it is legitimate. But can a spouse rent a residence to a Schedule C business of the other spouse? 

 40:46

And we have functional Augusta Rule 2.0. The business gets a deduction, the spouse does not have to include the income, the rental income in gross income. Yeah, it’ll work, it’s just really bad optics. 

 41:04

So again, in general, rental to a spouse can be deductible, but specific examination of how the courts view ownership interests in question. Again, this is state by state, and it depends on the nature of the ownership. 

 41:16

There are different ways for spouses to own property together. It could be joint ownership, it could be community property, it could be tenancy by the entirety’s, and it varies from state to state. Now, I did not go through and figure out 150 permutations. 

 41:31

In other words, in 50 states, how is joint ownership treated in Ohio? How is community property? the ownership treated in Ohio, assuming it can even exist there. How is tenancy by the entirety is treated in Ohio? 

 41:43

That was too much work. I gave you an example of a case and the general proposition that a spouse can be treated differently as a different person than the taxpayer for purposes of the Augusta Rule. And again, we discussed the optics. 

 42:00

You may rent to a C corporation. Let’s say the same attorney had the practice run through a C corporation. He has a residence that’s owned in tenancy by the entirety by himself and by his spouse. Could he rent to his law practice that is run through a C corporation and it’s legitimately viewed as a separate rental? 

 42:20

Yes, the case law is very clear. There’s a long list of cases. The seminal case was decided by the Supreme Court way back in 1943. This is the Moline case. And you’re gonna hear about this one again because the courts and the IRS latch on to the Moline case frequently. 

 42:38

The Moline case said that a C corporation absent really weird circumstances such as that the C corporation is a sham or there’s some other extreme weird fact pattern. C corporations are separate people from their owners. 

 42:56

Why do we care about that? When I rent a residence to a C corporation even if I own 100% of the C corporation, the C corporation is a separate person. It is allowed to be a tenant for a property that I personally own. 

 43:14

I am a separate person from the C corporation for federal income tax purposes and more specifically for purposes of renting property from myself to the C corporation which is the whole gist of the Augusta Rule 2.0. 

 43:31

I rent my personal residence to the C corporation. The C corporation if we follow all the rules gets the deduction, the income to me, the rental to me, is tax exempt. That’s the whole point. We want to have the business be viewed as a separate person by the IRS, by the courts, by the law for purposes of the Augusta Rule. 

 43:55

And there’s a long long list of cases that say C corporations are separate persons. So when we have a client with a business, even if they own a hundred percent of the business in a C corporation or an LLC taxed as a C corporation, it is able to rent from its shareholder. 

 44:14

That is legitimate as long as the other I’s are dotted, the other T’s are crossed, and that is the Moline case. This was a great example. I bring up the Feldman case because it’s often cited in the context of rentals between closely related persons. 

 44:33

Am I closely related to a C corporation? I own 100%. Oh yeah, yeah, that’s a pretty close relationship. Feldman addresses rentals in these close relationships. You will note from the citation, 84 Tax Court One, it is not a tax court memorandum. 

 44:51

It is a full tax court opinion, which means it carries extra weight. They were deciding what at the time they viewed as a novel issue, and so they had the full tax court make a decision. This is a frequently cited case. 

 45:04

In Feldman, he rented a portion of his home to a C corporation in which he was a significant shareholder. Now it was a CPA firm, a tax firm. So he’s renting part of his home to the C corporation. He was a significant shareholder and had a lot of power in the C corporation. 

 45:24

The IRS, knowing about the Moline case and what the Supreme Court said, that in Moline, C-corps are separate people. The IRS didn’t even try and argue that the C corporation was not a separate person for tax purposes. 

 45:39

They conceded that because the Moline line of cases is just that well established. Rather, the IRS argued that the rental agreement existed on paper only and served no business purpose of the lessee, essentially that it was a sham, essentially that there was no substance to the form. 

 46:00

The court stated, the IRS is correct in asserting that the lessor and the lessee heron dealt at less than arm’s length. In other words, they’re related persons. And that the rent paid to the shareholder was in excess of fair market value. 

 46:16

So the rent was very generous. It was higher than the true fair market value. But the court continued, these two facts do not necessarily destroy the bona fides of the rental arrangement, however. A close relationship between a lessor and a lessee does not mean that a valid lease agreement between them cannot exist. 

 46:36

But it does require a careful examination of the circumstances surrounding the arrangement to determine whether or not the payments are in fact for the rental of property. So where related persons are concerned, which is always the case with Augusta Rule 2.0, we have a person they are renting to a company that they own some or all of. 

 47:00

So the Feldman facts always apply, which means the court, the IRS, are going to take a closer look. The court went on to state, similarly, the payment of excessive rent does not necessarily taint the character of the entire payment. 

 47:20

The court then cited a case where the rent in a lease between related parties was excessive. But only the amount of rent that was excessive was disallowed. In short. When related party leases are in play, the courts will look to the nature of payments, were the payments really for the use of the property, and the reasonableness of the payments. 

 47:41

What would an unrelated person have agreed upon at a fair rental price? I would note that if a taxpayer goes too high on rent, it’s very explicit in this slide. If a taxpayer goes too high on the rent, it doesn’t mean that the whole transaction fails. 

 47:59

Rather, the amount of rent that is excessive will be disallowed. So the transaction is not destroyed, it is modified. The Feldman court decided that part of the payments were for use of the shareholders property, that is a home office, and they were therefore rent. 

 48:19

The court further ruled that the degree of business necessity for the rental went far beyond the standard required for a deduction, ordinary and necessary. What the court is saying is that we easily met the ordinary and necessary standard of section 162. 

 48:37

The court said that it was the shareholders, the court then said that it was the shareholders’ idea to rent the home office to the company, that the shareholder had enough clout with the company to make it happen, and the taxpayer knew the code does not undermine the agreement. 

 48:55

The court said it was a bona fide lease. This is really important. A lot of practitioners are uncomfortable with how structured the Augusta Rule 2.0 transactions are. These are structured transactions, but they’re legitimately structured. 

 49:10

What the court said here was, do you meet the criteria of section 162? And here, the taxpayer easily did. They wanted an office in the home to work away from the CPA practice where they could work quietly, they could do deep work, they could have privacy, they could work when they didn’t want to go into the office. 

 49:30

Those were all legitimate business. reasons to have in this case a rental in the home. Code section 162 is rarely a barrier. Now the IRS always checks it in the Augusta rule cases. We’re going to see that. 

 49:43

We want to document it but it’s usually easily met. Furthermore the fact that this is being structured, I mean the court said it, the taxpayer had this idea. The taxpayer was a tax CPA. They’re very tax-savvy and they had the ability to force the company to pay the rent which in this case was excessive rent. 

 50:05

None of that destroyed the transaction. It was still a legitimate lease and that is what mattered. This is really important for practitioners who get a little squeamish with, well the Augusta rule 2.0 seems kind of structured. 

 50:21

It is. The question is, is it correctly structured? This slide is the full tax court saying we don’t care if it’s structured. We care. is it structured properly? Do you have actual rent? And is the amount of rent reasonable, what a normal arm’s length person would pay? 

 50:43

The business necessity. The company, I’m quoting straight from the court, the company had a business necessity in providing the shareholder with an office space outside of company headquarters that was comfortable and convenient for the shareholder. 

 50:58

The fact that the location of the office was convenient to the shareholder does not override the business purpose. Now bear in mind, this is an older case. This is before Section 280 Cap A. This is before that because Code Section 280 Cap A says, if you rent out the property and you have personal use, you cannot take losses on the rental. 

 51:19

So it would potentially interfere with the rental situation that they described. They described a long-term rental of the office. That would no longer apply for other reasons outside of this case. But the fundamentals of this case, that related persons can rent to each other as long as there’s an actual rental and the rental amount is reasonable, that still holds true. 

 51:44

This case is frequently cited. So don’t get caught up in the fact that this particular rental structure under modern day rules because of Code Section 280 A would not function any longer. The principles that led to the court’s decision are still highly functional, frequently cited, and part of modern law. 

 52:07

So for the Augusta rule purposes, we need to have legitimate meetings. We need to pass the Section 162 bar of ordinary and necessary annual or quarterly meetings because my other hat, I’m not just a tax attorney, I do a lot with asset protection. 

 52:23

And where do I jump on clients with LLCs and corporations that they don’t maintain them? What’s one of the requirements to maintain? LLC or C Corporation, annual meetings that are documented, that are substantive. 

 52:37

Now with AI we can record the whole meeting, scrub out the parts we don’t want people to see, and generate a really nice list of meeting notes. So taxpayers and owners of entities who expect to have asset protection outside of the tax world should be having annual and quarterly meetings. 

 52:56

That’s a legitimate non-tax business purpose. Client meetings, client social meetings, within certain bounds. We have to be careful with entertainment, capital raising, employee training, filming, like I’m doing right now within reason. 

 53:12

These are all legitimate section 162 business purposes. We want to have an activity that is ordinary and necessary for the business that’s a very low barrier and we want to be able to prove that we did so. 

 53:26

That’s where the taxpayers usually run into problems. Feldman brought this up. Feldman easily passed the test. The court made it clear that a true lease resulted from one actual rental of the property to the lessee, which means a rental agreement and that there’s actual use of the space, a clearly identifiable physical space that was the subject of the lease. 

 53:52

You have to define what is being leased and what is not being leased. For example, for reasons we’ll get into later, under the Augusta Rule 2.0, we exclude the home office. If we’re renting a home for the Augusta Rule 2.0 to a business, if there is a home office and the taxpayer is taking a deduction for the home office elsewhere, one wants to exclude the home office from the lease. 

 54:20

So the lease agreement and the actual use should exclude the home office. What is being rented should be made very clear. Three, that the space has an identifiable rental value. This is where we need to go out and get our comps. 

 54:36

We need to do comparables and see what would a meeting space like my home comparable to my home rent for. And four, the deductions were supported by proof of costs attributable to the leased space. That’s a little bit less important in the modern context because of Code Section 280, Cap A. 

 54:55

Again, this case was decided before that so the costs of renting the space would actually have been relevant in that time period. They no longer are because there’s been a change in that part of the law. 

 55:08

The amount must be reasonable. Having accepted that the payments made by the company to the shareholder were in fact rent, the court then examined whether the amount paid was reasonable. Because the shareholder was an officer and shareholder in the company, however, we must look beyond the agreement of the parties to the lease to determine a reasonable rent. 

 55:29

In other words, when we have related parties the court is saying here is a direct quote we’re not going to accept your rental amount if your rental amounts too high we’re going to reduce the amount that we allow as a deduction and to determine what’s a reasonable rent we’re going to look at what would a normal person what would an outsider a third party at arm’s length pay and that’s why for the Augusta rule 2.0 contemporaneous well-documented comps what would this space rent for those are they’re essential they’re not extremely important they’re absolutely essential and this is where many taxpayers fail both the taxpayer and the IRS presented testimony from expert witnesses as to the proper amount of rent the taxpayers expert testified based on the number of rooms in the home versus the number of rooms used as office space the IRS’s expert testified based on relative square footage of the office versus that of the entire home The court held that the square footage method was more precise and therefore applied that number, 

 56:36

which happened to be 9% of the total square footage of the home. So again, what happened here? The taxpayer kind of did it quick and easy, quick and dirty. Let’s go ahead and just count the number of rooms. 

 56:49

We’re renting one room to the business. There are this many rooms. Let’s say the one room was 20% of the total rooms. 20% of the total square footage is how we’re going to determine the rent. And the court came back and said, well, the IRS’s expert did a better job. 

 57:06

They actually measured the square footage and the square footage was only 9%. They measured the square footage of the whole home and looked at the square footage of the rented area. They determined it to be 9% and the court went with that lower number because it was more precise. 

 57:21

To be clear, what am I saying and not saying? I do think it’s a best practice to measure the square footage that is actually being used for the Augusta Rule. And you have an incentive as a taxpayer to use more square footage. 

 57:35

There’s a rental of square footage. We can just say, you’re renting the whole house because that’s how it is. And we’re going to argue that it’s all the square footage. Well, understand that a court may come back or the IRS may come back and say, well, how much square footage did you actually use? 

 57:49

You weren’t using the home office. You weren’t using the bedrooms, we hope. How much square footage did you actually use? I would document that. Taxpayers don’t want to do that. That’s part of the problem with the Augusta Rule 2.0. 

 58:02

It requires a lot of documentation. It’s why we came up with a service combined with an app that helps make these tasks a lot easier. There’s a lot that has to be done to make the Augusta Rule 2.0 work. 

 58:16

That would include measuring the square footage of use, the square footage of the home, and figuring out comparables based on square footage. That takes work. We do as much of that for you as possible. 

 58:29

We make the rest of it very easy. and we automate the substantiation process of tracking these numbers once they’re entered, of printing them out. Our goal is if one of our clients has an audit that is using our service and our app, if there’s an audit that we respond to the IRS examiner the next day, that we print out of the app all the necessary substantiation, and we have it to the IRS examiner the next day. 

 59:00

I have done that in actual audits and the psychological impact on the examiner has every time. I’ve done this twice, both times when the taxpayer was so well organized that I walked in the next day. One case it was physical, the agent was nearby geographically, one case it was fax, because we all know the IRS still uses faxes, but in both cases I had everything to them. 

 59:23

Full substantiation the next day, the audit immediately ended. They knew they weren’t going to get anything out of us. They didn’t expand the audit to other issues or questions. The audit simply ended, because they knew we were not a good target. 

 59:36

We had our substantiation in order. The purpose of the service and the app is not just to make all of this easier, and that’s relevant because I just introduced a complication. Measuring the square footage is harder than measuring by the room. 

 59:51

It’s harder, it takes more effort. Measuring the square footage used is harder. And then you have to substantiate it. For example, we encourage clients to spread out and document that you did so. When you’re talking to the AI that’s recording, let’s say your annual meeting that you have for the Augusta rule. 

 01:00:07

So your company is renting the space to have its annual meeting that is needed for asset protection. We want you, when you’re talking to the AI recorder, which is gonna create the notes that show that there was actually a meeting, that the meeting met a business purpose. 

 01:00:23

We also want you to mention, hey, let’s move over to the dining room and have a cup of coffee. Let’s move to the back porch and have a beer. Let’s go back to the living room. Some people are getting massages in the upstairs rooms and hopefully nothing else and hopefully completely appropriate massages. 

 01:00:39

If you’re going to use the space, make sure it’s brought up in the notes. Once you’ve measured the square footage once, taxpayers always complain about it. We ask them, you just do it once, please. Measure the square footage of the whole house. 

 01:00:53

Measure the square footage you’re using once and then it’s in the app and the app will apply it for all future meetings. It makes it easier, but this case indicates why we want to do that. Now, can a taxpayer still measure by the room? 

 01:01:09

Sure, they just need to understand that if an IRS agent knows what they’re doing, that the courts value precision and that the square footage method is more precise and that the courts may disallow some of their rent because the square footage result may be less than the room by room. 

 01:01:29

result. You just have to explain that to the client. Look, you can do a less precise method. You can go room by room instead of square footage. That’s fine. Go ahead and do it. Just understand that the courts favor precision and that if there is an examination and an agent knows what he or she is doing, they’re gonna go for the more precise measure and they’re gonna peel some of that rent off of you. 

 01:01:52

As long as they’re fine with that risk, it’s the same as should I charge the highest rent I think I can justify. Yeah. Now, might the IRS come back with counter comps and say that rent’s kind of high. 

 01:02:06

We’re gonna disallow some. Okay, that’s fine. There could be an understatement penalty. Usually, this number is not big enough that we get into understatement penalties unless the IRS can show negligence. 

 01:02:19

In other words, 662A is not generally a problem here because the Augusta rule rentals are not large enough that if they’re allowed but reduced. Do we pass the threshold where there’s an automatic 20% penalty? 

 01:02:33

Typically not. So I tell the taxpayer, look, go with the highest reasonable amount that you think you can justify based on your comps. It’s the same as, look, go ahead and go by the room if you want. 

 01:02:43

I prefer you go by the square foot. The case law is going to be kinder in that regard. But what’s the consequence? Nobody goes to jail. Probably won’t even be any penalties. Maybe, but probably not. We warn the client there could be. 

 01:02:56

We do provide best practices. The best practice is to use square footage, not go by the room. But is going by the room fatal? No. Is setting the rent too high but still defensively high? Is that an automatic, uh-oh, we got big problems? 

 01:03:12

No. It’s just in an examination, the amount of the deduction that’s allowed is going to be reduced. That’s usually pretty much it. So a summary of Feldman. The courts look closely at related party leases. 

 01:03:28

One must show payment for the use of property. There has to be actual payment. This cannot be just a bookkeeping entry. Lease agreements, we have to have this. We talked about square footage and actual payment. 

 01:03:41

We have to show that the rent is reasonable. That’s why contemporaneous comps are important. We must show a business purpose for paying the rent. That’s usually pretty easy. We gave some examples. Excessive rent will be disallowed, but the reasonable portion of the total rent will be allowed as a deduction. 

 01:04:00

That the taxpayer structured this, that they made it happen, that it was tax-motivated, doesn’t matter as long as the other factors are met, the other tests are passed. The more precise measure of fair market value wins. 

 01:04:16

Doesn’t mean you have to be perfect on your fair market valuation, but it does mean if the IRS comes in with something more precise, they’re probably going to knock your value down some. And again, these principles appeared. 

 01:04:27

I have read now hundreds of cases looking at these issues and the Feldman principles, whether or not they cite Feldman, appear repeatedly in close rentals, that is rentals between related parties, which is what the Augusta Rule 2.0 is. 

 01:04:46

Another case is the Christopher Nigg case, where it wasn’t really rented. So Christopher C.L. Nigg, Inc., so it was a professional practice. It’s a tax court memo. A doctor rented the upper story of his home to his medical practice, and his medical practice was a C-corporation, so it fits with the facts of Feldman so far. 

 01:05:08

The home office had a separate entrance and security system, which I think helps him, but the MD never saw patients there. He did perform admin tasks there and met with his admin assistant and malpractice lawyers. 

 01:05:21

The C-corporation paid the entire home’s mortgage as rent, so clearly no attempt to look for someone else. comps they just picked a pretty arbitrary number and paid that. I would also note again this is before section 280 cap A that doesn’t matter right in other words new law says you wouldn’t be able to rent this business you wouldn’t be able to rent your residence to your business because of other other issues you wouldn’t be able to rent for the whole year there would be other issues under two section 280 cap A that would prevent that but the case principles overall are good what are we really focused on is this a legitimate rental that’s what we’re after that is still good law in terms of the principles raised in this case. 

 01:06:10

So the rental deduction was disallowed because the taxpayer did not produce any evidence of a written rental agreement or other documentation to support its position that the amounts claimed were actually rent. 

 01:06:25

Dr. Nigg also did not treat the arrangement with the corporation as a bona fide rental arrangement as he did not report any reciprocal rental income on his 2012 and 2013 schedules E. So the problem we have is that we followed Feldman but what happened he couldn’t show he had actual rental he didn’t have the court said basically this was just a way for you to get money out of your C corporation to you but it wasn’t really rental it’s really more of a disguised dividend also this is important the bolded part we want to see reciprocal reporting in this case because it did not meet the Augusta rule in other words he was renting himself to the C Corp the C Corp took a rental deduction he never reported the rental income that hurt him as it should we want to make sure with the Augusta rule 2.0 that we report the rental income on schedule E even though it’s exempt Typically it means reporting the amount of rent on the top line, 

 01:07:31

gross rental income, and then having an offsetting deduction that I just named section 280A, cap A, little g, and it’s exactly the same amount that excludes the rent and it results in net income of zero. 

 01:07:46

But this case makes clear that part of what the court’s going to look at, listen, if the business is taking a deduction for paying rent, we want to see the individual reporting the rent, and I think that applies even though the rent is exempt. 

 01:08:01

Also, it’s a more business-like practice. In other words, I think the business, just as it would 1099 anyone else to whom it paid rent, should 1099 the taxpayer. That’s not a big additional burden. You’re already, presumably, doing a bunch of 1099s for the taxpayer, add one. 

 01:08:20

The rent paid for the Augusta rule should be 1099. Now, what’s the problem once a 1099 is in the system? Skynet looks to see where that number was reported. If the taxpayer receives a 1099 saying you should report rent, you better report rent. 

 01:08:36

If not, that’s when Skynet generates letters and then they become annoying because the IRS ignores them or loses them and you spend a bunch of billable time or worse yet non-billable time dealing with the issue. 

 01:08:48

To avoid that, to make Skynet see what it thinks it wants to see, report the 1099 rental income on Schedule E and then just take an offsetting deduction for Code Section 280, cap A, parentheses g. By the way, I would not call the deduction the Augusta Rule. 

 01:09:05

I’ve seen that on some tax returns. I think that’s terrible optics. The Augusta Rule, because of so much garbage on TikTok and elsewhere online, has a bad name and that’s not just with practitioners, it’s also with the IRS. 

 01:09:23

S-Corporations, let’s go ahead and fast forward to the spoiler, S-Corporations are treated like C-Corporations. Now, there’s an argument that an S-Corp should not be treated as a separate person because it is a pass-through entity and the IRS has addressed that issue. 

 01:09:40

The IRS has said in repeated publications, repeated letter rulings and other technical advice memorandum, et cetera, the IRS has repeatedly said that we view S-Corporations like C-Corporations to fall under the Moline court case. 

 01:09:58

They are separate persons for tax purposes unless the code explicitly says otherwise and it does when it comes to passing through income. So the default the IRS takes is that Moline applies to S-Corporations unless the code says it does not. 

 01:10:16

Well, the 1300 section of the code spends a lot of time talking about it does not. In other words, when it comes to income, there’s no double taxation. There’s pass-through of the income from the S-corp to the individual. 

 01:10:31

So bottom line, S-corps are going to get very similar treatment to C-corps, really identical treatment, when we’re thinking, is this a separate person for tax purposes? Let’s go through and prove it. 

 01:10:43

So I fast-forwarded to the conclusion, and if that’s good enough for you, if you trust me in spite of the fact that I’m a lawyer, then you can go ahead and fast-forward. But if you want evidence, let’s get into some IRS rulings. 

 01:10:56

In IRS letter ruling 2017-47-006, this is consistent with the IRS’s overall attitude towards S-corporations as entities separate from their owners. In that letter ruling, the IRS argued that the Moline case that we had discussed said that C-corporations are separate persons. 

 01:11:16

And remember, for the Augusta Rule, the business being a separate person is good, because you can rent to a separate person, but you cannot rent. to yourself. So this is the answer we want. The Moline case applies to S-corporations in spite of a few weird cases that went to the contrary and the IRS methodically in this letter ruling refuted one of those weird cases which was Morton. 

 01:11:44

Now take a look at the citation for Morton. It doesn’t surprise me the citation. When do we get weird tax rulings? When we go outside of the tax court where the specialists who live and breathe tax law live and we go to a district court or the federal claims court or a federal appellate court where the judges are more generalists and they don’t understand tax law. 

 01:12:09

In fact sometimes we have a jury involved. So cases that are outside of the tax court that involve taxes sometimes bring us to really weird rulings. Sometimes that’s good. I know attorneys that when their client’s case is not really very good they don’t want to go to tax court because those judges actually know what they’re doing with tax law. 

 01:12:32

They actually will try and go to district court or the court of federal claims hoping to get a judge who uses common sense and doesn’t understand the law or hoping in some cases to get a jury where they might otherwise not get one and then you get these weird rulings and I think Morton was one of those weird rulings that said an S corporation really is not a separate person and the IRS came back and said oh yes it is we disagree with Morton and the IRS cited a bunch of cases that said listen Morton is wrong Moline is right S corporations are separate people but there has been a little bit of disagreement and the IRS went straight at it. 

 01:13:15

The ruling held that the service should regret the Morton holding and continue to assert that Moline properties are applicable to S corporations. Importantly regardless of whether the S-Corporation is wholly or majority owned. 

 01:13:31

Again, this is very important. The IRS is saying that when an S-Corporation is 100% owned by one person, it’s still a separate person from its owner. Let me repeat that. This is really important because there are other tax techniques besides the Augusta Rule. 

 01:13:48

For example, people selling their personal residence to an S-Corporation to take advantage of Section 121, a tax-free sale. Well, can we have a sale from me to my S-Corporation? According to this PLR, yes. 

 01:14:03

Why? Because the S-Corporation is a separate person. So I sell my home to my S-Corporation. I don’t pay any taxes, presumably, because of Code Section 121, but I still get a large step-up in basis because the S-Corporation takes a purchase price basis. 

 01:14:23

This law is important, not just for the Augusta Rule. but for other reasons, and the IRS was being very broad. And they explicitly said, look at the language, the service should reject the Morton holding, the weird one, and continue to assert that Moline Properties, which says C-corps and now S-corps are separate persons, they should continue to assert that Moline Properties is applicable to S-corporations regardless of whether the S-corporation is wholly or majority owned. 

 01:14:54

So again, I know it seems a little weird to some practitioners and S-corp is 100% owned by a person. Common sense might be, you know, that’s really fishy and weird to treat them as separate and that they have transactions with each other. 

 01:15:07

But what this ruling is saying is the IRS says they are separate persons. They can have transactions with each other, including rental transactions. So the IRS, by the way, the IRS continues to follow this position. 

 01:15:21

So I’m giving you one document, one example, of where the IRS argues S-corporations are separate persons. In other words, you can rent to them. And the IRS has followed this ruling many times. The IRS continues, in some cases, an S-corporation separateness has been assumed. 

 01:15:41

In other cases, courts consider and ultimately reject the position that S-corporations might not be treated as separate due to their pass-through nature. So once again, the IRS is saying, usually the courts assume an S-corporation is a separate person. 

 01:15:56

Sometimes they’ll consider but reject the idea that S-corporations might not be treated as separate because they are pass-throughs. The letter ruling then lists and summarizes a long list of cases to back up the IRS’s point. 

 01:16:11

In other words, they wanted to show that Morton was an aberration. And to do so, they listed a ton of cases showing that S-corporations are people too. S-corporations are separate people too, just like C-corporations. 

 01:16:26

The Moline case from the Supreme Court does apply to them. Separate ruling here, Technical Advice Memorandum 2002-13007. In the Technical Advice Memorandum, an S corporation rented a property to another S corporation with almost identical ownership. 

 01:16:45

The auditors wished to disallow a rental deduction based on the nearly identical ownership of the S corporations. The IRS attorneys advised in the Technical Advice Memorandum its IRS attorneys advising field agents or examiners. 

 01:17:01

The IRS attorneys advised that in the absence of any evidence that either S corporation was a sham, the Moline line of cases required respecting the separate existence of each corporation. In other words, a related person renting to or from an S corporation is fine, always subject to taking a close look at the lease. 

 01:17:24

seeing if there was an actual rental arrangement, if the amount of rent charged was appropriate, but the IRS came back and said, one S-corp renting to another S-corp, they are each separate persons, we are going to treat them as such. 

 01:17:37

So no field agent who’s asking a question, you cannot conflate the two and treat them as if they were the same person. So the IRS pretty consistently, actually very consistently, treats S-corps, C-corps, LLCs taxes S-corps, LLCs taxed as C-corps as separate people, which is the answer we want for the Augusta Rule 2.0. 

 01:18:01

Let’s move to partnerships. And I’m gonna use the term partnership generically. A tax partnership would include multi-member LLCs, it would include LLP’s, LPs, various other entities, it would also include general partnerships. 

 01:18:16

So they are separate. Tax partnerships are separate persons for federal income tax purposes. And this was not hard to prove. If we take a look at Treasury Reg 1.707-1A, let’s read from it. A partner who engages in a transaction with a partnership other than in his capacity as a partner, shall be treated as if he were not a member of the partnership with respect to such transaction. 

 01:18:44

What might a capacity other than as a partner be? Landlord, that is a capacity that is not in one’s capacity as a partner. Reading on after the green. Sets transactions include, for example, loans of money, I’m a lender, or property by the partnership to the partner, so I’m acting as a lender, not a partner, or by the partner to the partnership. 

 01:19:05

The sale of property by the partner to the partnership, the purchase of property by the partner from the partnership, and the rendering of services by the partnership to the partner or by the partner to the partnership. 

 01:19:16

In other words, all of these, it’s a list of examples of where a partner is not acting as a partner. And this says, when a partner’s not acting as a partner, they shall be treated as if they were not a member of the partnership. 

 01:19:30

They will be treated as a separate person. When one is acting as a landlord instead of as a partner, that’s clearly a situation where what? We are a separate person. So here, we’ve got it in the regs, nice and clear. 

 01:19:46

Treasury Reg Dash 1.707 Dash 1A goes on to say, where a partner retains the ownership of property but allows the partnership to use such separately owned property for partnership purposes. For example, to obtain credit or to secure firm creditors by guarantee, pledge or other agreement. 

 01:20:07

The transaction is treated as one between a partnership and a partner not acting in his capacity as a partner. I would note this helps us. This is not exactly a rental situation. It’s actually the partner letting the partnership use the property, arguably. 

 01:20:22

contributing the property to the partnership. But what this says is, no, we’re gonna treat that as separate, even if no rent is charged. When we charge rent, especially reasonable and documented rent, documented by a lease with an actual rental occurring, I think it’s even better facts than what’s described here. 

 01:20:40

In other words, this is a lighter standard. We are doing more than what is described in this regulation. We have actual rentals, actual rental agreements, actual payment of rent, so the separation between the partner and the partnership is greater than is described in this slide. 

 01:20:56

Continuing, however, transfers of money or property by a partner to a partnership as contributions, or transfers of money or property by a partnership to a partner as distributions are transactions included within this section. 

 01:21:11

In other words, when you’re treating a partner as a partner, so will we. When you’re treating the partner as a separate person, so will we. That’s the whole gist of these regulations. So a partnership is a separate person. 

 01:21:25

I tried to find cases that contradicted the clear language of the regulation that I just cited to you in order to prove a negative, and I just couldn’t do it. I couldn’t find anything to the contrary because the regulation is so clear. 

 01:21:40

Now, I did find a few partnership cases that, again, I just thought were interesting and continue to back up what we’re saying, that when we look at related parties, renting to an entity, whether it’s a corporation, S Corp, C Corp, LLC, partnership, the courts tend to look at the same factors over and over again. 

 01:22:04

You’re gonna see the Feldman factors in interior SEC Corp here. There were rental properties, and by the way, this was a great tax arbitrage case. I really liked the outcome. Rental properties in several C corporations. 

 01:22:17

So the C corporations had title and owned the rental properties. We’re at least… partnerships with very similar ownership at a very low price. Partnership that, so the lessee, the partnership lessee that had almost exactly the same owners as the C-corps, then sublease the rentals out to the public at a much higher price. 

 01:22:38

Think about what was happening here. These properties are trapped in C-corporations with all the associated problems of rental properties being in C-corporations. How do we bail some money out? Let’s go ahead and rent the properties cheaply to a partnership that has pretty much the same owners as the C-corp. 

 01:22:56

It’s an indirect way of renting to the C-corporations owners. We’re gonna rent at a low price and that way the owners of the C-corp, the shareholders, indirectly through this partnership can sublease at a much higher rate. 

 01:23:11

What are we functionally doing? We’re bailing value out of a C-corporation but avoiding the double tax. And the IRS really did not like that. They argued that the partnership was a sham, and the lease was just a tax scheme to move income from the corporation to the shareholders under Code Section 482. 

 01:23:34

Under Code Section 482, the IRS can take a look at prices, at transfer pricing, in this case the rent between the corporation and the related partnership. And if certain criteria are met, they can allocate, they can make their own price. 

 01:23:49

They can say, this is a fake price, we’re not buying it under Section 482, we can force the true price, the true rent in this case. And by the way, the IRS lost. The court held that the partnerships were created for legitimate business reasons and cannot be viewed as shams. 

 01:24:09

The partnerships performed valid managerial services as to the operations and maintenance of the rentals, including efficiency of centralized management, especially for consolidating expenses. Section 482 allows the IRS to correct fake prices between related parties, but the IRS must prove shifting of income, which I kind of thought we had here, between related entities. 

 01:24:34

The court concluded there was none in the instant case, in other words that the transaction efficiencies of management to attain efficiencies of cost was legitimate and allowing the person to whom you rent to have a markup to profit from creating that efficiency is a legitimate structure that it was not a sham. 

 01:25:00

And therefore the leases were legitimate. So game over, the related party leases that in this case provided serious tax benefits were upheld. This is a great case. This is an extreme case. When I started reading it, I did not think the taxpayer would win because frankly, I think that what the IRS accused taxpayers of doing is exactly what they did. 

 01:25:22

that they were doing, but they did it right. They did it such that under the specific terms of 482, it was still okay, according to the court. What the IRS never bothered to challenge, I mean, they had to argue it was a sham. 

 01:25:35

If you remember, going back to the Moline case, corporations, including us corporations now, are treated as separate persons, unless what? The corporation is a sham, which means basically super fake, very fraudulent. 

 01:25:48

There’s just no substance or reality to it. And that’s what the IRS tried to argue here, that there was a sham. But the standard for arguing that there’s a sham is very high. And in this case, the IRS failed to prove that standard. 

 01:26:01

Therefore, the court held that the entities were legit, and the transactions, when it looked at them closely, were also legitimate, or at least not subject to attack under 482. Maybe there was a better way for the IRS to attack it that they missed, but 482 was not the way. 

 01:26:19

The court went on. It is very well established that a taxpayer has the right to choose the form of organization that will achieve a desired business result, citing Polak’s brutal works. By the way, this line of cases deserves a CPE of its own. 

 01:26:37

It deserves a class of its own. Because I get into this issue with auditors periodically that, well, you get these benefits by the choice of entity and substance over form doctrine says you can’t really do that. 

 01:26:48

Uh-uh. There are cases that say choice of entity is inherently a form-driven thing and that the substance over form doctrine does not apply when choosing entities. It’s inherently form-driven and the IRS will both respect the form but also hold you to the form. 

 01:27:09

So a very important point here that was made that I wanted to point out. Procacci (94 T.C. 397), this is another fun partnership case. A corporation operated a golf course leased from a partnership with exactly the same owners of the corporation. 

 01:27:25

So very similar to the prior case. The corporation is leasing a golf course from a partnership. So the C-Corp is the operating entity. It’s leasing from a partnership that actually owns the property, identical ownership. 

 01:27:40

Sound familiar? That’s what we’re trying to do with the Augusta Rule. And as you’re going to see from the result in this case, once again, if it’s done right, we can do it. It’s very normal. I just wanted to show you cases to give you a comfort level with different fact patterns, different circumstances, different mixes of entity types. 

 01:27:58

Is the lessor or a C-Corp or a partnership? Is the lessee or a C-Corp or a partnership? I wanted to mix it up and vary it some and I wanted to show you how consistent these cases are. The Augusta Rule 2.0 is legit if done right. 

 01:28:12

The criteria the courts apply to see if something is legit are very consistent regardless of the entity types involved. So in Procacci, an operating company, a corporation, leased a golf course from the owner. 

 01:28:27

The owners of the partnership and the C Corp were identical. Now, interestingly, this is where it gets fishy, where you can understand what the IRS said. Hey, what’s going on here? The corporation was never able to pay the rent for the golf course, because there were losses on the course. 

 01:28:45

The IRS tried and failed to allocate rental income to the partnership via section 482. The C Corp conducted a thorough analysis of what an arm’s length third party lease would have looked like. Because remember, we have related parties. 

 01:29:01

And here it’s really fishy. There was no rent ever paid. There was a rental agreement. There was rental of the golf course to the operating company. The operating company actually used the rental property to run a business, but not paying any rent at first appears to be really fishy. 

 01:29:17

So we can understand what the IRS thought. Let’s go to court, we’re gonna win this one. The court concluded, and this was a very long case with a lot of expert testimony, testifying to how golf course rentals are really weird and funky, but we have to look at that because they’re very consistently weird and funky. 

 01:29:38

The court concluded that zero rent for an unprofitable golf course that also involved profitable home development around the course was reasonable. What happened? Turns out that based on reading this case, you learn so much reading these cases. 

 01:29:55

There’s always a story. A lot of the times when a golf course is built, it was never really built to make a profit. It was built to make development around the golf course very profitable. We build houses around a golf course, it’s profitable. 

 01:30:10

We don’t have a golf course. I know, let’s build a golf course. The houses sell. The same people that own the golf course make a ton of money on the sale of the subdivision that surrounds the golf course. 

 01:30:21

The golf course is then left, and it is in of itself not profitable. If you look at how much can be charged, how many people visit it, especially if it’s a private club, the golf course itself is not profitable. 

 01:30:34

That’s what happened here. And the court said that’s fine, and the expert witnesses for the taxpayers came up with many examples in the industry of where golf courses were rented, but the rent never ended up being paid because the golf course was not profitable. 

 01:30:50

And that the context frequently was why would someone do that? Why would someone rent a golf course for zero is what the IRS asked. And the answer was because they already made their money. The golf course wasn’t designed to make money. 

 01:31:04

The surrounding subdivision and development and sale of the subdivision was, and the golf course made that sale much more profitable. And therefore, zero rent for a golf course in many contexts is actually what happens with normal. 

 01:31:20

third parties. So here it seemed weird that related parties said, ah don’t worry about the rent and normally that would be a problem. Normally that would be a problem and the court looked and said you know that’s kind of weird. 

 01:31:33

Related persons we need to see rent. We need to see the same rent that we would see out in the market with unrelated persons. But what happened here? We did have in the marketplace unrelated persons zero rent for golf courses and the IRS lost. 

 01:31:49

Note the IRS didn’t even try to argue that rental from a C corporation, in this case, renting from a partnership owned by exactly the same owners was a problem. They have accepted the partnership as a separate person. 

 01:32:04

The C Corp is a separate person. So again for the Augusta rule when I’m renting to a C Corp or an S Corp that I own a hundred percent of, not a problem. It’s a separate person. It can be a legitimate rental if the details are right. 

 01:32:18

Likewise, renting to a partnership in which I’m a partner. Not a problem if I’m truly being treated as what? A landlord. If I’m being treated truly as a landlord, I am not acting in my capacity as a partner. 

 01:32:30

And the regulations say when you’re not acting in your capacity as a partner, we’re going to treat you as if you were acting in that other capacity. Percocci really backs off that idea. Spousal partnerships. 

 01:32:42

Here’s where it gets a little bit funky. This took a lot of research. It’s really easy to read the cliff notes here. Some of you probably did that and aren’t hearing me right now because you just went through the AI notes and took the conclusions and the case law. 

 01:32:54

But this did take a lot of research. These are figuring out which entities are treated as separate people, including with spouses. Now, spousal partnerships, including LLCs whose members are just two spouses, are still partnerships for tax purposes. 

 01:33:12

That’s very important. My spouse and I own a home and we’re renting it to our LLC. And the only two owners of the LLC are me and my spouse. Can that be a legitimate lease? According to Argosy, yes. Partnerships, LLCs, the members are just two spouses, are still partnerships for tax purposes. 

 01:33:35

And therefore, we go back to then how are partnerships treated? They’re treated as separate persons from the partners when the partners are acting in a capacity other than as a partner. For example, when they’re acting as a landlord. 

 01:33:50

So can a spousal partnership, let’s say an LLC owned by two spouses, rent the residence from the spouses? Yes, it can. Argosy and the regulations. However, is it still bad optics? Yeah, yeah, it’s not great optics. 

 01:34:07

So if there’s another way to do it, try to do it that other way. Well, they have an S Corp. Can I just go ahead and rent to that business instead? That’s better optics. On the other hand, sometimes the facts are the client says, well no, we don’t have an S corp. 

 01:34:23

Or the S corp’s not doing any business that would justify renting space from the owners. And really if we wanna do the Augusta Rule 2.0, our only choice is this LLC owned by two spouses is going to rent from us. 

 01:34:37

Okay, just understand the optics are not great. The IRS is more likely to challenge it. Because again, we have financial incest, but it is legal financial incest. Community property states are a little bit weird. 

 01:34:51

I’ve listed them there. In a community property state, spouses can choose to be treated as one, or they can choose to be treated as partners. And the IRS will honor the choice. Furthermore, one can change their mind. 

 01:35:08

It is not a binding decision. For example, I own rentals in California, a community property state. I file the rentals on schedule E. of my 1040. I have chosen to treat the spouses as one and the IRS will honor that decision. 

 01:35:27

No, you know what? I bought rentals in an LLC in California. The spouses are deemed to own 5050 and I file a form 1065, a partnership return. The IRS will honor that choice. You have chosen in a community property state for spouses to be treated as partners by filing the partnership tax return, the 1065. 

 01:35:49

The IRS will honor that. So you have a choice in a community property state of let’s say the taxpayers own a business jointly, a non-corporate, because we already know if the taxpayers own an S-corp or a C-corp together, that’s a separate person. 

 01:36:06

The taxpayers have a business in California. It’s in an LLC. I can choose to treat that business as a sole proprietorship by filing on Schedule C. Now that makes it harder to use the Augusta Rule 2.0 because as you remember from our first case that we discussed, the business that the business owned by the taxpayer can rent from the spouse but not from the taxpayer. 

 01:36:31

So you’re probably looking at a 50% disallowance in that instance. Or in a community property state where the taxpayers run an LLC together, they have a business together, they decide we’re going to file as a 1065. 

 01:36:43

Can that same exact business now rent the taxpayer’s residence using the Augusta Rule 2.0? Yeah, yeah, because a spousal partnership, which in the community property state we get to choose whether or not it’s a spousal partnership, a spousal partnership will be respected by the IRS. 

 01:37:05

You’ll get some pushback because it’s not the best optics but the IRS will respect it or be forced to respect it under the case law I cited. . So, summary, a lot of case law, a lot of research, a lot of time on my part spent here, but it really boils down to C-corps, S-corps, LLCs taxed as C-corps, LLCs taxed as S-corps, multi-member LLCs, limited partnerships, any other tax partnership, including between husband and wife are separate persons for the Augusta Rule purposes, 

 01:37:45

and you may rent your residence to any of those entities. You cannot rent your 100% owned personal residence to your 100% owned Schedule C, E, or F business. You should be able to rent a residence owned 100% by your spouse to your Schedule C, E, or F business, but do expect that the bad optics will result in the stink eye in an audit. 

 01:38:13

You may be able to get a 50% rental deduction when renting a property owned by your Schedule C, E, or F business. by both spouses and this only matters if the business itself is schedule C, E, or F. Again, if the business is a corporation, S or C, if it’s an LLC with multiple members, if it’s a tax partnership, that last piece doesn’t matter. 

 01:38:35

When you’re renting a jointly owned property, spouses, it only matters when you’re renting to a sole proprietorship, whether it’s a sole proprietorship on schedule C, E, or F. Then you’re probably going to get a 50% rental deduction. 

 01:38:51

It really depends on state law and how it treats the particular ownership methodology, whether it’s joint, whether it’s tenancy by the entirety, et cetera. 162, ordinary and necessary. So for the Augusta rule to work, the company that pays the rent needs to deduct the rent for tax purposes. 

 01:39:13

162 governs a business’s deduction of rent and a whole bunch of other expenses. For an expense to be deductible, it has to be ordinary and necessary. Now the courts have been very liberal in construing those words in favor of taxpayers. 

 01:39:27

In other words, this is a really easy hurdle to clear, but it still does need to be documented. One of the things I found, I pulled, and you will see, was a famous Augusta rule case that occurred about a year, year and a half ago, and the taxpayers lost based on substantiation, which is usually how it works with the Augusta rule. 

 01:39:54

What the IRS challenged, both in its briefs and in its memoranda, those are also online for you to look at, and what the IRS pushed the taxpayers on in examination. That’s where you’ll see the transcript of the trial. 

 01:40:07

So I pulled the transcript of the trial. I pulled the questions that the IRS lawyers asked the taxpayers, and they pushed hard on why did you have, why did you have to have the meeting? in your house? 

 01:40:19

Huh? Huh? Why couldn’t they be at the gym? Why couldn’t they be at the hospital where you worked? Why did the meetings have to be in the home? Now, the tax court never addressed it. I think had they done so, the taxpayers would have won. 

 01:40:33

Because as you’re about to see, the courts are very, very forgiving, very liberal with what is ordinary and necessary. The taxpayer doesn’t have to prove that meeting in the home was better or cheaper than meeting somewhere else. 

 01:40:50

They just have to prove it was useful to the business. That’s it. But you do have to prove it. You have to have a legitimate reason for renting the residence to the business. There must be a legitimate reason that reason has to be documented and that reason has to exist in fact. 

 01:41:07

It can’t just be fake that you said you were going to do this and you didn’t do it. But with that said, if you do that, I think your code section 162 issues are not likely to be a problem. It’s just not a big hurdle. 

 01:41:19

For example, the seminal case for 162, Welch v. Helvering, the Supreme Court ruled that necessary imposes only a minimal requirement that the expense be appropriate and helpful because initially the IRS was very literal and they said it was necessary. 

 01:41:35

Necessary means the expense under 162 has to be ordinary and necessary. Necessary means if you don’t do it the business dies. That’s one interpretation of the word necessary. And what the court said, that’s not really what Congress meant. 

 01:41:49

That’s not how they use the word. They use the word necessary to mean appropriate and helpful. That’s a very low standard. You have to rent the property, the residence, to your business and you have to do it for a reason that is appropriate and helpful to the business. 

 01:42:04

And I gave examples before of employee meetings, training people, raising money, having business meetings, having annual meetings for the company, etc. I don’t think that’s really very hard. In Commissioner v. 

 01:42:19

Taliaire, the Supreme Court reaffirmed that courts have consistently construed the term necessary as imposing only the minimal requirement that the expense be appropriate and helpful for the development of the taxpayer’s business. 

 01:42:33

So again, very low standard, easy threshold to meet the various sorts of meetings, gatherings, trainings, all of them can pass this test, but you have to document it and you have to really do it. Note, none of this says the taxpayer has to be present. 

 01:42:51

I have seen Augusta rule cases where the taxpayer’s company, other employees or other shareholders or other contractors, whomever, they have a meeting at the taxpayer’s residence and the taxpayer is not even present. 

 01:43:08

As long as the meeting or whatever they’re doing at this rented residence is legitimate, as long as it’s helpful and appropriate. for the business. Nothing says the taxpayer actually has to be there. 

 01:43:22

I don’t even think that’s bad optics as long as the meeting itself had significant substance to it or whatever the activity was. The company is paying rental for the residents. Whatever activity is conducted by the company at the residence, was it appropriate and helpful? 

 01:43:39

That’s the only question that’s really being asked. They don’t ask, was the taxpayer there? They don’t necessarily need to be. Again, I’m a lawyer. I don’t read requirements into the code that aren’t there. 

 01:43:54

There’s no requirement that the taxpayer needs to be present. Now they often are and that’s fine, but it’s not necessary. Ordinary. So the courts have defined ordinary because remember for Code Section 162, we have to show that an expense to be deductible is ordinary and necessary. 

 01:44:14

And again, they’ve defined ordinary in a very taxpayer-friendly fashion, including some pretty weird deductions that were still considered to be ordinary. In Commissioner v. Heininger, a dentist, sold dental supplies by mail and fought a fraud order from the postmaster general. 

 01:44:31

He lost, by the way. He still deducted the legal fees. Now the IRS argued that fraud, and especially lost fraud cases, this is not an ordinary thing. This should not be deductible. This is highly abnormal. 

 01:44:45

You can’t deduct that. And the court, the Supreme Court, came back and said, sure you can. They said ordinary in this context does not mean that the payments must be habitual or normal in the sense that the same taxpayer will have to make them often. 

 01:45:01

A lawsuit affecting the safety of a business may happen once in a lifetime. The counsel fees may be so heavy that repetition is unlikely. Nonetheless, the expense is an ordinary one because we know from experience that payments for such a purpose, whether the amount is large or are common, are accepted means of defense against attack. 

 01:45:23

So ordinary is, again, very broadly defined. You can do some pretty weird things, pay for them, deduct them, because they’re ordinary, even though they’re uncommon or weird. 162 and rent. Taxpayers frequently pay rent for the use of space, such deductions are routinely allowed as long as the use of the space was for a purpose helpful to the business. 

 01:45:46

Once again, annual corporate meetings or quarterly, training contractors or employees, certain employee entertainment events, cost to sell to customers or the public in general, cost to raise funds. You wanna host a fundraiser. 

 01:46:01

I buy real estate. I need investors to invest in my real estate. I have a meeting showing why you should invest with me and I choose to use my home for that meeting. I choose to rent my home to the company that is raising the funds. 

 01:46:14

to give an example, have all been ruled to be deductible. As such, anything that serves legitimately, serves the purposes of the business, ordinary and necessary, useful and helpful, if a bit weird, are deductible. 

 01:46:27

So we look at the underlying activity. How do we determine if paying rent for something is legit? Well, what did you use the space for? Was the use of the space ordinary and necessary? Was it helpful and appropriate? 

 01:46:41

It could be weird, it’s still ordinary. What did you use the space for? You have to document the actual use. You have to document why that use was helpful. Usually the notes do it. For example, most meetings, most of the things I’ve described here either have, if you’re training contractors, employees, for example, there’s going to be an agenda and there’s going to be a list of who was there. 

 01:47:04

That’s probably enough. If you are bringing in clients to try and get more business, you would have an agenda of what to do to discuss. How long did you spend on it? You want to have enough time that it’s legit, right? 

 01:47:17

It’s an eight-hour meeting. We drank for seven hours. That’s probably not going to do it. You want to have a meeting that’s long enough to have substance. I like at least four hours. I personally think the optics of four-plus hours are much better. 

 01:47:31

Who’s going to rent a space for the whole day when you’re not using at least half the day? That makes no sense to me. So again, you want to think about documenting. When you are recording meetings, let’s say you have your annual corporate meetings. 

 01:47:44

You record those meetings with AI. You clean up the AI. Boom, you’ve got meeting notes. That’s extremely useful. It’s not just useful. It’s mandatory. You’ll see in some other instances people who did not, they couldn’t prove the meetings happened. 

 01:47:57

They couldn’t prove what happened during the meetings. Lose these Augusta rule cases. So again, the rent is deductible if the underlying activity was useful or helpful to the business. And you can prove it. 

 01:48:11

And testimony later, oh, yeah, man, that meeting was awesome. Dude, like we rocked it. We got so much out of that and stuff. That was just wicked cold stuff. That’s not going to do it. Testimony gets shot down frequently in tax court. 

 01:48:25

You want meeting notes. You want agendas. You want lists of attendees. And by the way, lists of attendees are what? Also a list of potential witnesses. Now, do you really want to call them? No. But does the IRS really want to fight against them? 

 01:48:37

No. So again, document. Do things that are helpful to the business and be able to prove that what you did was useful to the business. How do you lose these cases? Documentation. For example, meetings, again, must prove to have occurred. 

 01:48:54

The business purpose of the meeting and the meeting must be contemporaneously documented. You’re not going to like this. It means you have to document this during the meeting. You take, again, you turn on AI, record the meeting. 

 01:49:07

Have an agenda done before the meeting. Take some notes during the meeting showing that you followed the agenda. What time we got to point, point A, what time we got to point B, et cetera. Have a contemporaneous list of who showed up. 

 01:49:18

Don’t do it after the fact. Do not procrastinate. Our app makes this a lot easier. You input all of this into the app. Good Lord, AI makes it easier to record the meeting. Now you might want to clean up the notes some depending on whether things got said during the meeting. 

 01:49:34

You know, a little editing can be useful. If you don’t do it, delegate it to somebody. There are ways to make this easier. Our app is designed to make it easier. It stores all this information because what is our goal? 

 01:49:45

If there’s an audit, I want the file on the IRS examiner’s desk the next day. I want the psychological impact of we were waiting for you, buddy. We were ready to go. But don’t do fake documentation. They look for it. 

 01:50:01

They sniff for it. And it kills your credibility. Especially, let’s say you’re in an audit where you have a bunch of issues, not just the Augusta rule, and you fudge the documentation. You lied about the date. 

 01:50:14

You did the documentation later, and then you lied and wrote that you did it the same day. Don’t do that. Don’t lie. And second, if they catch you, at a minimum, what happens? You lose credibility. Now, everything else you do is going to come under much, much more scrutiny, and they’re not going to believe you. 

 01:50:30

It goes to court, for example. Your testimony is worth a lot less once they’ve caught you fudging, faking, or lying. Don’t do that. I know you don’t like paperwork. Your clients don’t like paperwork. 

 01:50:41

You have to record these meetings. You have to have agendas. You have to have lists of who showed up, and they do need to be contemporaneous. Getting into that habit is invaluable. I’ll take meeting notes done after the meeting over no notes, but it’s really suboptimal. 

 01:50:57

I really need to see, to defend this in tax court, contemporaneous notes. But we’ve got to watch out for entertainment facilities. Things are deductible. Rental is deductible. Paying rent is deductible under section 162. 

 01:51:14

Unless what? Unless what? We are renting an entertainment facility. The code is, unfortunately, very tightly written. It pretty much says that any entertainment facility is a place where entertainment occurs, which is really original. 

 01:51:28

Nice job, Congress. Thank you. Anywhere entertainment occurs is an entertainment facility, and paying rent for an entertainment facility is non-deductible. That’s what the code says. So if the courts wanted to read it very literally, they could disallow anything. 

 01:51:45

For example, I know that when I travel, I get to deduct a hotel room for the travel. But did fun ever occur in the hotel room? Was there ever entertainment in the hotel room? If so, it’s an entertainment facility. 

 01:52:01

My home. I want to rent it, but did fun ever occur there? Based on the literal reading of the statute, if any fun ever occurred in my home, it’s an entertainment entertainment facility and if anyone pays any business pays rent to rent my home which is an entertainment facility because somebody had fun at some point then they disallow the deduction well no that’s an absurd interpretation there’s case law on this and it tends to be certain types of property are considered to be per se entertainment facilities you just you could pay rent all day but it will never be deductible or almost never be deductible and then there are some facilities that are borderline like they’re nice and bougie enough that yeah maybe that’s an entertainment facility let’s take a closer look and see what happens but here’s the key the Augusta Rule 2.0 does not work if your residence is an entertainment facility if your residence is an entertainment facility the deduction is disallowed and so we have to look for this and we have to try to not become an entertainment facility a per se entertainment facility and this is just based on the case law and the listings of Treasury Reg Section 1.274-2E4, 

 01:53:17

Roman numeral three. Boats and yachts, hunting lodges, and fishing camps. Look, I get it. The boat is technically a residence. Can you sleep there? Can you cook there? Does it have a bathroom? Yeah. Yeah, it’s technically a residence. 

 01:53:32

But if you want a deduction for renting your boat that is a residence to your business, you have to make sure it’s not an entertainment facility. What’s the problem? The problem is there are a fair number of cases that it’s just really consistent. 

 01:53:46

Yachts and really nice boats, hunting lodges, fishing camps, are almost always, I mean, almost always under the case law and explicitly in the regs, viewed to be entertainment facilities. Those deductions are almost always dead. 

 01:54:03

What I tell people is, with very few exceptions, and there are some exceptions, I would not, for example, try to use my yacht, which is technically a residence if you’ve been on it for 14 days, I would not use my yacht as an Augusta rule rental to my business. 

 01:54:18

Or at least if you do so, be aware you may lose the deduction. Because the case law and the regs consistently treat yachts regardless of what you did on it for the business meeting. They treat the yacht as an entertainment facility, and they almost really don’t care that your meeting was legitimate business. 

 01:54:38

Now there are exceptions to that. What’s a maybe entertainment facility? Maybe, the classic case is Ireland, I’ve cited it there. The taxpayers had a beach house. So it’s like, hmm, that’s kind of bougie, it’s really nice, we see entertainment potential. 

 01:54:56

They had legitimate business meetings, but they also had a much larger number of family members staying there and having fun. And so the court said the primary use of the beach house was entertainment, and therefore it was an entertainment. 

 01:55:11

facility. So if you’re going to use a beach house for meetings, don’t have fun. And I’m serious about that. They will ask. If you look at the transcript of the Sinopoli case, if you look at the questions the IRS lawyer asks the taxpayers, they dig. 

 01:55:30

What was the business purpose? Why did you do this? What did you do? Where did you do it? Was it near a beach? Where are you having fun? Were people taking lines of cocaine off the mirror? Okay, they didn’t actually ask that, but you get the idea. 

 01:55:45

So you can convert something that is especially the IRS tends to look at the more bougie things like a beach house and say, listen, if there is any entertainment, if there’s any entertainment, they can just say it’s an entertainment facility. 

 01:56:01

As a practical matter, they tend to look at was it primarily business or was there very little entertainment. was their very little entertainment. It was truly primary business. Here, bringing along family that the IRS said probably enjoyed and probably stayed the night, and the family outnumbered, in this case significantly, the number of taxpayers having business meetings meant that the deduction, 

 01:56:25

the rent paid for the beach house was not allowed. The rent paid for the beach house was not allowed. So, we’ve got our per se entertainment facilities, hunting camps, fishing camps, boats, and then we have borderline stuff, something that’s really nice, kind of subject to entertainment, and the court and the IRS will look, what did you do? 

 01:56:46

What did others who were with you do? And if there’s too much entertainment, whatever they figure that is, then they’re gonna disallow the deduction. So again, can you, on a tax return, let’s say a taxpayer does this, can you sign the return? 

 01:57:04

I think you can sign the return, but I would have a note with the client in writing, saying, look, I think I have enough to sign the return, 20% reasonable basis, but if the IRS looks at your facts, I think there’s a good chance they’re going to conclude that there was too much entertainment, because whether or not there was too much entertainment is gray, that’s what gives us the 20% reasonable basis. 

 01:57:25

Was there too much entertainment on your particular Augusta Rule rental? I’d sign the return, but I would make the client sign something saying, look, this is edgy. I don’t know if you’re gonna win this. 

 01:57:37

They could penalize you for this, because you’re not allowed to deduct payments for an entertainment facility. So am I good signing it? Yes. But I also would warn the client in these edge cases of, yeah, the IRS may look at this, and they’re really, really all over that someone have fun. 

 01:57:56

Was there entertainment? And if it’s deemed to be too much fun, you’re gonna lose, you’re probably gonna pay some penalties. So do be aware of that. Now, there is a company party exception, code section 274(e)(4), the gist.

 01:58:09

If there are more normal W2 employees plus their family members, then there are management plus their family members present, then expenses for entertainment, and that would include renting a yacht, include renting a beach house, include renting a hunting camp, are deductible. 

 01:58:28

Because the point of a company party is to have fun, so entertainment is explicitly allowed. I would note, this only applies to W2. W2 means W2. Any non-W2 attendee does not count as not management. So this really only applies to employees. 

 01:58:48

But if you can show there were more employees, including their family members, than there were of management, and I’m defining it loosely, because I don’t really want to dig into the code section, it’s TMI. 

 01:58:59

If there are more regular line people than management, owners, highly paid executives, et cetera, then… That’s fine, you can deduct the entertainment for the company party and you don’t have an entertainment facility problem. 

 01:59:14

The other relevant exception, there are a bunch of exceptions. I only picked the ones that I thought were very relevant. Certain business meetings are allowed to be entertainment and therefore part of an entertainment facility. 

 01:59:27

Expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, and the question becomes, are owners of an LLC stockholders? Because stockholders are technically only for corporations and an LLC is not a corporation. 

 01:59:44

Would the courts view members of an LLC equivalent to stockholders? Common sense says yes, but if you read it literally, it says no. So there is a little bit of risk there. I do think the court would probably say members of an LLC and stockholders are pretty much the same thing. 

 02:00:00

I don’t know that, but I think that’s what would happen. Business meetings of stock employees, stockholders, agents, or directors. Now agents is an interesting one. What on earth is an agent? I have to do more research into that. 

 02:00:14

I had to at some point finish this and put it out there, this rough draft form so that I can convert it into an actual creditable course for CPE and other equivalent credits. But who is an agent of the taxpayer? 

 02:00:30

Because having agents at a meeting and having entertainment is okay. But if somebody’s not an agent of the taxpayer, now it’s not okay and we may lose our deduction. So this is an exception. This is when entertainment and entertainment facilities are okay. 

 02:00:52

Sinopoli, this is the best known Augusta rule case. I could only find two others that really dealt with the Augusta rule, but Sinopoli is the one that squarely dealt with the Augusta rule and it’s pretty recent. 

 02:01:03

Sinopoli was a doctor and the Sinopoli case was actually three different doctors in the same practice, and it was consolidated into one case for efficiency purposes. So there were actually two other doctors involved. 

 02:01:15

Sinopoli was one of the doctors. He used a tax consultant who recommended a marketing C corporation. That’s a different and fun webinar, by the way. The IRS looks for consulting fees and marketing fees, because it usually indicates BS. 

 02:01:32

It often indicates transfer of income to somewhere else. And it’s usually lacking in substance, which, by the way, is what happened with the marketing C corps. The IRS, the tax court, looked at the marketing C corps and said, there’s no real substance here. 

 02:01:48

You’re just trying to shovel money into a C corporation in order to get a lower bracket. But the format in which you shoveled money into the C corps wasn’t real. You didn’t really have a marketing C corporation. 

 02:02:00

It was a marketing company, the same as. Some companies, this is especially common with physicians, dentists, that there’ll be a services company that provides admin services to the practice or consulting. 

 02:02:15

That’s a case of it can work if there is true marketing, true consulting, and true admin services provided. The problem is all of those things take a lot of work and taxpayers often skip that part and the tax consultants don’t focus on making sure you do those things. 

 02:02:33

So they give you a template and then if you don’t follow it they just say, well, you didn’t do what we said too bad and that happens very frequently. They also recommended the Augusta Rule. The problem was with the tax consultant there was no implementation, they gave the ideas but there was no hand holding to help the taxpayers properly implement. 

 02:02:52

Taxpayers, entrepreneurs, businesses always think they’re going to implement, they in fact rarely do. What I have found personally and how I’ve modeled my tax planning practice is we help implement, it does cost more and of course clients don’t like that. 

 02:03:07

But we tell them if we just give you recommendations we don’t know that you follow them. Now if they insist, well, we just provide recommendations and make them sign a big waiver that says, if you don’t actually implement in the way we describe, this will not work and you will fail and you will pay taxes and you will be penalized and it’s your fault, yeah. 

 02:03:25

But we usually try to get them to pay for a package that yeah, it does cost more but it actually works. We actually implement and this is an example of what happens when the implementation followup is absent which is normally the case. 

 02:03:39

So in Sinopoli, the MDs owned a Planet Fitness, actually several Planet Fitness franchises and in the beginning they used to have meetings at the hospital where they worked or at the franchises. Now the IRS pushed really hard on why are you having the meetings at home? 

 02:03:54

You could just do it in the hospital or at the franchise, you don’t need to. First of all, I think the IRS would have lost on those grounds. If that was their only attack on the Augusta Rule. 2.0 the sole attack was we didn’t need to have the meetings at the home. 

 02:04:07

There was a better way to do it You could have done it at the hospital No, the code section 162 cases don’t require that they’re very light in terms of was the meeting helpful Not was it the cheapest or optimal way to do it. 

 02:04:20

They don’t have that requirement so I think the IRS pushing on that they’re barking up the wrong tree and Interestingly, the court pretty much ignored the IRS and they in order for the court to decide Sinopoli, which was a taxpayer loss There were other deficiencies on the taxpayer side that were so great. The court never had to address the issue of did you have a good business purpose for having these meetings? 

 02:04:44

By the way, when I read the testimony in the transcripts, the examination and the cross examination I thought that the taxpayers answered quite well. They said listen the hospital and the gym, the problem is we’re known there. 

 02:04:56

We can’t get quiet. We’re not in the place or a state of mind where we can do deep work or real thinking or have useful meetings. And also we’re always being interrupted. Somebody’s coming up and asking questions, they know we’re there, they’re pulling us to the side. 

 02:05:11

We can’t really have privacy. We can’t really do this without interruptions. Do I think that’s a good enough reason? I think that’s more than a good enough reason. I don’t think they needed those reasons. 

 02:05:22

I think those are just slam dunk reasons for, yeah, we’re doing this at our house. I don’t think you have to justify why you’re doing it at the home. I think you just have to justify that having the meeting at the home was what? 

 02:05:35

Useful and appropriate. So Sinopoli had one meeting a month at his home and he charged the partnership rent of $3,000 and the other doctors did the same. Sinopoli, unlike the other two doctors, initially researched comps to try and establish proper rents for his home. 

 02:05:53

Fatally, the comps were dated and hence not contemporaneous. Now the IRS agent did his own comps. He lowballed. He went to the YWCA and said they’re renting square footage for nothing. Guarantee you’re not going to like the IRS’s comps. 

 02:06:11

So he found very cheap venues and he said that, look, the fair rental wasn’t $3,000, it was $500 and I’m going to allow that much. Now the court said, I mean, Sinopoli, first of all, never responded with comps of his own because the IRS is always at a disadvantage on comps. 

 02:06:28

You can do contemporaneous and should do contemporaneous comps. That’s something that we have a research service that does it for you. You should do contemporaneous comps at the time. You should do comparables once a year and use that for a year and then update it after a year. 

 02:06:45

That’s contemporaneous. Contemporaneous usually means that day or on the spot. For example, meeting notes should be on the spot during the day. Contemporaneous with comps is a little bit more liberal. 

 02:06:56

Interestingly, Sinopoli never responded with comps. comps of his own, which just surprised me, because he could have possibly, I think he could have come up with better than 500 bucks. He did have some comps that justified three grand, he just never updated them. 

 02:07:09

Why didn’t he go update them? I’ll never know. Probably too busy, he’s an MD, he’s got a lot to do. Understand that you always have an advantage over the IRS. Their comps are never contemporaneous. Their comps are when the audit occurs. 

 02:07:22

The audit occurs usually years after the fact. If you have contemporaneous comps, you have an advantage over them. But even if you don’t, which I think is silly, you really should, even if you don’t, you can try and come up with comps at the same time, they do. 

 02:07:37

Now, Sinopoli, for whatever reason, didn’t do that, and it cost him the case. He lost on this. Family members were home during the meetings. That’s bad optics. The court mentioned it, so the IRS lawyers did ask, did you have family members around? 

 02:07:52

Because typically, when I rent a space to somebody, I am renting the space to them. There are no others present. So having family members at home during whatever your activity is I think is a strong bad optic. 

 02:08:07

I think it hurts you especially if one of the goals is to have peace and quiet around the house. So just saying I think it’s a lot better optics if the family is not there. I think it’s a lot better facts if they’re not. 

 02:08:16

The meetings usually had three partners, not two. They did save driving time and hotel costs so that was another reason that they wanted to have the meetings at the homes. Here’s the problem one of the other problems, so problem number one is that they didn’t really have contemporaneous comps and so the court just went with the IRS agents number 500 and the court even said the IRS agents number is generous because the IRS agent didn’t have to do that. 

 02:08:44

He could have just said your comps are not current and therefore I’m giving you zero deduction. He could have said that and that would have been it and he probably would have won. In fact the court pretty much indicated that’s all they had to do was disallow the deductions. 

 02:08:57

Why? Because they were not supported. They were not properly documented. The substantiation was inferior and that includes no credible evidence of the business actually conducted at the meetings. There were no notes. 

 02:09:10

The IRS lawyer used this against the taxpayer. If you look at the transcript when he was questioning the taxpayer in front of the judge he told him you work in an industry as a doctor where documentation is everything and you didn’t document these meetings. 

 02:09:25

I don’t think these meetings happened and in any event the burden of proof is on the taxpayer to show the meetings did happen. Of all the meetings that were held there were 12 per year over three years so that’s 36 times three because there were three taxpayers so that’s 108 meetings. 

 02:09:44

Only nine of them had notes. Dr. Sinopoli had notes for his meetings. Those meetings were allowed; those nine meetings were allowed at 500 each so he passed the test on notes for nine of the meetings and failed all the others so they were just disallowed, no notes, no proof of what happened. 

 02:10:02

People always think, well I’ll just tell the IRS, I’ll tell the judge, their testimony was found to be not credible. You’ll see that here in another slide. So again, this is all about the proof. Sinopoli is a very typical case, not just with the Augusta Rule, just in general. 

 02:10:17

Taxpayers, as I said in the beginning, don’t tend to lose because they don’t deserve the deduction. They tend to lose because they don’t have the documentation, the substantiation, and that’s exactly what happened to the Sinopoli case. 

 02:10:29

Augusta Rule 2.0 requires a lot of substantiation. We’re going to summarize it at the end of the presentation. You need to have that. We try and make that easier with our service, and it’s fine if people don’t want to use our service, just they should make sure they follow the best practices list. 

 02:10:45

There need to be meeting notes. There needs to be contemporaneous documentation of how much the rent should be. The IRS did argue that the renting the home to the business was not ordinary and necessary, the court just ignored the argument because they were able to decide the case on other grounds, and that’s very common. 

 02:11:08

If the court already knows the taxpayer is going to lose, they’re going to tell you why you lost in the shortest manner possible. They’re not going to address other arguments that, oh, by the way, you might have also lost on this. 

 02:11:19

They just tend to ignore. The court agreed that no reading, meeting notes, plus testimony that was not credible. The doctors couldn’t remember the exact times of meetings, how many occurred, what was discussed. 

 02:11:33

I mean, who would remember that? This is three years worth of meetings. It looks like three meetings per month. And they ask you, tell me what you said at the third meeting of June, 2016. Who the heck is going to remember that? 

 02:11:46

Nobody, not in any credible fashion, not unless you’re Rain Man or somebody. That’s just not going to happen. And so the court said this is not credible. We need notes. And so they allowed the meetings that had the notes. 

 02:11:58

They disallowed all the others. So there, I’m just repeating what I’ve told you because I don’t know, I just kind of like to repeat myself. I actually just want it to stick. I want it to stick. So once again, meeting notes, plus contemporaneous documentation of how you derived the rental amount is necessary or you lose. 

 02:12:20

So he’s not really lost again, because he couldn’t prove the IRS attorneys. Interestingly, take a look at bullet point number two, the IRS attorneys explicitly declined to attack the exclusion of the rent of income under section280 cap A,g. 

 02:12:38

We have the opening brief page 21. So I pulled the briefs and memoranda that both the IRS and the taxpayer filed. Those are in the materials that you can access via the various links. The IRS attorneys never attacked the Augusta rule itself. 

 02:12:54

They never attacked code section 280 cap A, gee they didn’t disagree they’re just not going to go after that because it’s so clear where do they attack we want to see your documentation prove that the rents are accurate prove that they were contemporaneously found and decided on a reasonable basis that the amount of rent is what a third party would have paid prove it with records done at the time prove that the meeting or the activity actually occurred we need contemporaneous written notes lacking that you lose but going after the Augusta rule itself no IRS lawyers didn’t even make the attempt so the IRS attacked the rental rates were unreasonably high that was in the IRS brief page 28 most meetings were not documented same no actual rent was paid IRS memo page 6 now they seem to have dropped that later so they do look to see if actual rent was paid lazy taxpayers do not pay rent they just put an expense on the books of the company saying, 

 02:13:58

oh, well, we’re going to debit an expense, and we’re going to credit some other account, a distribution, the taxpayer, or a deemed contribution by the taxpayer, more likely? No. Actual rent needs to be paid, not just a bookkeeping entry. 

 02:14:15

The IRS argued that the meetings were not ordinary and necessary and that renting a home was not customary for a gym. Really, they’re arguing that it’s not ordinary. That was in their memo, page six, and in their brief, page 26. 

 02:14:28

I think they would have lost that case. If you remember, just because something’s weird, the legal fees for the dentist doesn’t mean it’s not ordinary. And I think the IRS here was arguing first very narrowly that renting a home is not customary for a gym. 

 02:14:43

It’s too narrow. They’re kind of arguing it’s not ordinary. I think they would have lost the agreement, but the court ignored C and D because A and B proved to be conclusive. So putting it all together, here we are. 

 02:14:59

Did a lot of research. I spent a lot of time figuring out who is a “person”. I kind of knew the answer ahead of time, but knowing the answer kind of is not the same as doing the research. So I spent a lot of time deciding, figuring out, researching which entities are people. 

 02:15:14

But we put it all together now. It’s been a long journey. The IRS is not challenging that rental income that meets the criteria of code section 280, cap A, g is tax-free. They’re not even challenging it. 

 02:15:28

A sole proprietor, including a single member LLC that is taxed as a sole proprietorship may not rent from himself. He may be able to rent from his spouse, but it’s bad optics. C corporations, S corporations, and tax partnerships may rent from owners, or to owners for that matter. 

 02:15:51

They may rent from owners. Spousal partnerships, in other words, spouses that file partnership tax returns should be able to rent to the business from the spousal owners, but it’s bad optics, and the law is a little bit unclear because it varies from state to state. 

 02:16:11

Now, I think it’ll be pretty consistent across most state lines, but it would require research and so on, so it is a little bit muddled. The IRS and the courts permit related person rentals, but they take a very close look at them, a very close look. 

 02:16:28

Go back to the Feldman case, that’s what it was all about, and what really all of these cases, including Sinopoli, have been about. Courts examine whether payments are truly for the space rental, and not for something else. 

 02:16:42

Now, how do we prove that payments were truly for a rental? First, we have a lease with realistic terms, arm’s length, we have that in our app, an automatic lease that auto-generates. The terms of lease are actually followed, that’s really important. 

 02:16:55

You have to. follow the terms of the lease. For example, if the home office is excluded from the lease, and it really should be, if one is taking a deduction for the home office, then you wanna maybe even put a little sign on the door, and if you’re feeling paranoid the way I do, take a picture of it that says, no admittance, not part of the rentals. 

 02:17:13

On the rental agreement, it says you can’t use it, and we even put a little sign telling people not to go in there. The lease agreements are drafted and executed in a timely fashion, not right before the audit. 

 02:17:24

We don’t do, as business people, when we do leases, we do it before we let someone in the property, we don’t do it later. So the lease agreements should be executed in a timely fashion, which generally means before the actual leasing occurs. 

 02:17:39

The courts examine whether payments are truly for rental space and not something else continued. D, the lease space is actually used as described in the agreement. So you have to have, again, notes of which space did we use, how was it used, and that’s where the notes for your meetings come into play, and notes on which space. 

 02:17:56

We went to the dining room and we had a little bit of stand-up wine in the kitchen. That increases the square footage being used. I like that. E, actual payment is made on time. It’s not made later. It’s certainly not made after the end of the year. 

 02:18:10

It looks really bad if it’s made any time. Some rentals will invoice after. I’ve seen that. I don’t think it’s a best practice. I think paying before is a best practice, or paying immediately after is a best practice. 

 02:18:22

You might get away with 30 days. You’re not gonna get away with more than that. That looks fishy. And paying after the end of the year is probably fatal if you look at how cash basis deductions work. 

 02:18:32

So timely and actual payment. The payments reported as rent on the residence owner’s Schedule E. Report them. Now, it’s gonna even out to zero net income, but we want it to be reported. We want it, 1099, to be issued. 

 02:18:48

It has to be ordinary, necessary, and reasonable. The activity in the rental must be one that is ordinary and necessary for the business. The activity needs to be strong, not just fluff, examples of fluff. 

 02:19:01

Annual quarterly corporate meetings that only include family members. Corporate annual meetings that only include family members. And this can go either way. I have some clients that really are a family business. 

 02:19:12

The kids are grown. They’re very actively involved. The meetings have really serious discussions. I’m fine with it. That’s not what I’m talking about. I’m talking about we have a family business meeting for the LLC. 

 02:19:24

It’s the two spouses and the children are employees and they are age one, seven, and nine. And we’re going to have a family meeting. That’s garbage. That’s just garbage. Oh, no. See, we’re training the future founders of the business. 

 02:19:42

Good luck with that. Seriously. I mean, the one-year-old’s pooping himself. What’s the one-year-old learning? Just distracting everybody by pooping himself. That’s no good. No. Make it realistic. If it’s a husband and wife friend business and you’re going to use annual meetings. 

 02:19:55

Optics are way better if some other humans involved bring in business cronies. You guys talk to your business cronies The entrepreneurs talk to their business cronies all the time over fermented grain products and dead cow and Deductive we’ll just transfer the setting Invite a few people who are active in your business Let’s say this is for a landlord business You bring in a few fellow landlords and as part of your corporate annual meeting you discuss Circumstances in the market where interest rates going how our rents looking is their rent control whatever that’s way more credibility now Look, 

 02:20:29

it’s your call. If you want to have an annual meeting between husband and spouse I will defend it, but it’s harder to do It’s not great optics if you have a family meeting and the kids are all minors and there’s no other Non family member present that’s hard to defend if you bring in others, it’s easier, but maybe you’re just not willing to do it It’s not worth the hassle. 

 02:20:48

That’s fine. There are trade-offs: You bring in more people. It’s a pain. You don’t bring in more people, it’s purely family and not family that’s actually heavily involved in the business, it’s bad optics. 

 02:21:00

There’s always a trade-off. You have to decide, you have to help the client decide which way to go. I’m just telling you what I want to see for tax purposes. I don’t always get that from clients Evity activity that is not at contemporarily documented in detail is dead We need the activity to be contemporaneously documented in detail both the rental comps and the meeting guys The AI makes this so easy for the meetings Meetings with entertainment better meet one of the two exceptions we discussed meetings with entertainment Better meet one of the two exceptions for more mainline employees w2 employees present than management W2 is present or one of those meetings of shareholders employees Agents board members, 

 02:21:46

etc If you’re gonna have entertainment you better meet one of those exceptions or it’s gonna get disallowed. We don’t want an entertainment facility meetings on yachts, unless you meet one of the exceptions, even if it’s a residence, that’s probably not gonna fly. 

 02:22:00

Will I sign the return? Yeah. Will I send the client an email that they have to agree to before I sign the return saying, you understand there could be penalties and you’re good with that, you’re willing to pay the penalties. 

 02:22:12

Entertainment, it’s weak. Given the case law, a nice boat equals entertainment facility and it destroys the Augusta Rule 2.0. It destroys the business deduction. Ditto hunting and fishing camps. There should be no entertainment on borderline properties, such as a beach house, something that’s sort of intrinsically entertainment related. 

 02:22:33

In general, the meetings should minimize entertainment. I’m fine with meals. I’m fine with a meal after the meeting, during the meeting, before the meeting. I’m fine with chit chat, serve some booze, smoke some cigars during that. 

 02:22:46

But entertainment outside of the meal context is not going to fly. It is very destructive. towards getting a tax deduction, especially when you’re dealing with a close thing, with a closely held rental. 

 02:22:58

You’re renting to related parties. Just kill the entertainment. Or make sure it meets one of the exceptions. Here’s an example, it’s really clever. Somebody called me with this one, and it was really clever, but I just thought it was too cute by half. 

 02:23:14

So 12 friends, financial friends, rent a Caribbean mansion for the year, so they get a cheap annual lease rate. Each friend with family lives in the mansion for two weeks, so everybody gets a month. They live in it for two weeks. 

 02:23:29

That makes it a residence for each friend individually. The mansion is then rented to the friend’s business for 14 days of the same month, so 14 consecutive days of meetings. How credible is that? Is that really gonna happen? 

 02:23:42

The IRS is gonna look at the documentation. Now look, theoretically it can be done. Maybe you really do have seriously legitimate business activities for the half of the month that the business is renting from you. 

 02:23:55

You use it as a residence the first half, the second half it’s renting from you. You have legitimate meetings. Now there are probably a bunch of family members having fun. There are probably a bunch of kids running around, which as you’ve seen from the case law, those are not good factors. 

 02:24:09

Economically it makes sense, because the daily rental rate is much greater than the prorated annual rate. So I might be paying, I’m making up a number now, a hundred grand to rent it for the year, but daily rates would add up to 300 for the year. 

 02:24:24

So there is some arbitrage, it’s clever in that respect. It’s just, I don’t think it’s a great confluence of facts. The IRS would scrutinize the living heck out of this. You better have perfect documentation. 

 02:24:37

You better have real substance to it. Again, this is kind of like the art donations where people go buy a bunch of art from one guy and then donate it to art, donate it to somebody two years later and they just keep doing it over and over and over. 

 02:24:52

It’s theoretically doable, and in practice, few people successfully carry it off. There are too many details that they neglect. It attracts too much IRS attention. It’s bad optics. And ultimately, when the IRS examines the details, these kinds of things ultimately tend not to work out. 

 02:25:12

Defensible activities. Look, I want at least four hours. You’re gonna rent for the whole day. You gotta have a long enough meeting to justify it. Don’t be lazy about this. Four hour plus meetings with a clear business agenda, preferably relevant non-family members present. 

 02:25:26

I can go with family members if it’s a lot of them, and it really is serious, hardcore business. I have seen it done. Family members of the residence owner are not present, unless they’re part of the meeting, legitimately part of the meeting. 

 02:25:40

The meetings are recorded by AI with solid, credible, edited notes as a result. It can include, again, annual or quarterly meetings for entities, preferably with some non-family members present. You could raise money, you could train employees or contractors, you could be selling to clients, educational presentations, metrics meeting in the EOS entrepreneurial operating system, aka traction methodology. 

 02:26:05

Entertainment can taint any of the above, exclude it, unless you clearly meet one of the exceptions. The IRS actively challenges the reasonableness of activity. They’re going to look to see if your meeting was reasonable and if it actually happened. 

 02:26:22

It needs to be reasonable, it needs to actually happen. Reasonable rent, you have to determine rental rates annually, yes, annually. That means contemporaneous, so we don’t exclude, or sorry, make sure to exclude rental or personal property. 

 02:26:39

For example, if you’re using a hotel for comparables and part of their rent includes screens and microphones and all this personal property, you probably want to adjust the hotel’s rent downwards as a comparable to exclude that personal property. 

 02:26:54

You want to document the square footage of both the comparables and the square footage of the residents, as well as the square footage that is actually used. You want to document the use of those areas, usually as part of your AI recording. 

 02:27:09

This is how the IRS wins right here. They challenge weak comps. And by the way, in the Sinopoli case, again, the auditor was kind of a nice guy. He allowed 500 bucks. He didn’t have to. He could have simply said, taxpayer, Sinopoli, you did not carry the burden of proof. 

 02:27:25

You did not contemporaneously document rental rates. I’m just disallowing all of it. Have a nice day. He could have done that. He chose to allow some. Last but not least, this is hard to get right. If you look at everything we’ve covered, there’s a lot of substantiation, which business owners, taxpayers hate. 

 02:27:47

There’s a lot of homework to be done. Some of you may justifiably concord that at least for some clients the Augusta rule isn’t worth it. The rates are too low, the work is too much. Now our goal with our app and our service is by researching we do provide higher rates than you would get by just looking at say Airbnb’s so there’s more to be saved and we also automate an awful lot of the work especially after that first time. 

 02:28:11

The first time when you’re dealing with the lease agreement and you’re documenting the square footage used etc that first time is always the pain just like with any learning curve. After that it gets a lot easier. 

 02:28:23

So we help with the documentation, the eligible uses, we do a lot of education, we do a lot of Q&A, we have FAQs because some of you come up with some interesting questions. Most taxpayers get it wrong, we help you get it right, cheaper, easier, faster. 

 02:28:38

The hoops are made easy if you look at theaugustarule.com. Last but not least, provide me feedback. Tell me how to make this better. What am I missing? Do you think something I put in there was incorrect? 

 02:28:50

Please do provide feedback. This is a rough draft for what will become educational credits for professionals. This is John Hyre thanking you for your time, your patience. I hope you learned a bunch. 

 02:29:02

I hope that we help you help your clients keep what they earn. Take care.