How to Determine Fair Market Rent for the Augusta Rule

Intro

How much money can you make with the Augusta Rule? The founder of the “Free Money” Plan uses it to pay himself $42,000 annually, for $17,640 in tax savings.

But that’s based on his property’s rental value in his local area. Real estate & rental costs are never “one-size-fits-all”. Residences in Santa Barbara, CA, might go for $10,000+ a day, while rentals are considerably lower in Dayton, OH (Sorry Dayton! Or “Congrats” on a reasonable cost of living). If you rent the home to your business for more than a reasonable amount… well, that’s exactly what the IRS looks for.

This article is a guide as to how to determine reasonable rents for your personal residence.

Where to Start

First, if time is scarce, you needn’t do this yourself. The Augusta Rule™ can do it for you.

We’ve found that custom valuations may often justify much higher (routinely 3x higher) rents than purely digital valuations would. We are glad to offer a complimentary custom valuation for 1 residence when you book a strategy call with us.

Home rental values are based on factors such as:

Square footage
Amenities
Condition
Location
High season vs low season
Age of home
Economic conditions

The key is to analyze the above factors in the context of your local market. This analysis should be repeated at least annually to pass muster in an IRS audit. Economic conditions may change (and quickly), supply & demand may vary, properties may fall off of or be added to the market, and so on. The key is to stay on top of the data in order to charge the most possible but not so much as to run afoul of the IRS.

Professional Rental Valuations

A professional rental valuation has its upsides. The IRS & Tax Court tend to find valuations by third parties more credible than DIY versions. The pros often have more data points and an intuitive sense of the local market – including comps that might allow an argument for higher rental values. Such valuations are also time savers which matters if you’ve more money than time.

Your main options are to:

Ask your realtor (if you have one) whether they or someone in their agency can conduct a “light” daily rental rate valuation (aka a BPO or Broker Price Opinion); or
Commission a full-blown appraisal of the property’s daily rental value by an appraiser or similar professional.

Is it worth it? “Depends”. If the professional finds better comps faster than you might, you’d like extra credibility should push come to shove, or time is scarce…then hiring the work done makes sense.

PS: As mentioned, we are glad to offer a complimentary custom valuation for 1 residence when you book a strategy call with us.

Self-Valuations

If you’re going to do your own valuation, it needs to be very well done. For those with the time & detail-oriented minds, DIY can make sense. Search near & wide, via a number of sources. Keep very good notes. Make the analysis credible – you obviously want the highest possible rental value. But if you put your entire weight on the scale (instead of, perhaps, a light thumb) then the entire analysis might be completely disregarded by an IRS agent. You should essentially conduct your own thorough & documented Comparative Market Analysis (CMA) by searching for comps in your area As a reminder, consider:

Square footage
Amenities
Condition
Location
High season vs low season
Age of home
Economic conditions

Be sure to seek properties that are rented for business purposes; residential rental rates are easier to find but the rental rates tend to be on the low end. Low rental valuations = smaller tax savings for you.

When analyzing similar properties, you should look for properties that have a history of actually being rented (e.g., a fair number of reviews). Be wary of relying on owners’ asking prices as opposed to actual rental prices. Useful and accessible sources of rental information include Zillow, Homes.com, Redfin, Realtor.com, AirBnB.com, and other similar sites. Such sites tend to have important information such as the age, location & size of a home; the condition of the home (usually in the reviews); amenities & desirability (more subjective unless the home is very near your own). Google Street View may provide a sense of the condition of the home and nature of the neighborhood. Getting a good sample size is essential, as is gathering the details that show that your residence is truly “comparable” to the properties used to derive a rental value. Fortunately, finding such comps & details can usually be done online. Be sure to focus on daily rates as opposed to monthly rates that are then pro-rated to daily rates – such an approach would produce horrifyingly low rental rates.

The most conservative daily rates can be found by searching short-term rental (STR) rates. These can be found through AirBnb, VRBO, and the like. If you take this approach, remember to look for features in the homes that match yours – location, size, condition, parking, amenities, etc.

Better valuations (“higher rents”) may be derived by calling hotels, convention centers, wedding venues, and other places that rent space for business events. Ask them what their rates are for the types of business events you’re planning to host, for the number of people you plan to include. Be sure to capture the square footage of the space – you’ll need to prorate it to the square footage of your home that is actually used. Hint: Spread out, use more square footage for your home meetings. Based on our reading of IRS cross-examination of taxpayers in the Sinopoli Tax Court case the IRS shall argue (likely successfully) to prorate “rental per square foot” value of venues to the square footage actually used in your home.

When gathering hotel, convention center, etc. rates, be certain to exclude the value of any non-rental extras included in the price: Sound systems, sound tech, food, and anything else besides the room and normal furniture. The idea is to derive a “per square foot” rental rate, less any non-real-estate rental items, and apply it to the square footage used in your home. The quality (“desireability”) of the meeting spaces should match that of your home.

Pay close attention to seasonal fluctuations in local rental rates – ask the hotels, meeting venues, etc. as to when prices are high & low, and what those prices are. If you rent your residence to your business during the high season, adjust accordingly. Likewise, if you rent your home during the low season, adjust accordingly. And please remember: Rental rates change from year to year, so this valuation process should become a regular habit each year.

Conclusion

If you wish to save time and money (when compared to BPO’s or formal appraisals) while creating peace of mind via a valuation backed by credible data, then please consider our “Free Money” Plan.