Can I Pay My Mortgage with 529 Plan Money?

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Mark Kantrowitz

By Mark Kantrowitz

December 30, 2019

Some parents save on room and board costs by buying a house or condo near the college campus and letting their child live in it while they are enrolled in college. After the student graduates, they sell the property at a profit. Since they can use a 529 plan to pay for room and board, can they use 529 plan money to pay the monthly mortgage bills?

Mortgage Payments Do Not Qualify as Room and Board

To be considered a qualified higher education expense, room and board expenses must be incurred by the beneficiary while attending the institution, per 26 USC 529(e)(3)(B)(i). The beneficiary is the student, not the parent. Since the mortgage was borrowed by the parent, not the student, it is not a qualified higher education expense.

Even if the student were to buy the home, they still can’t use 529 plan money to make the mortgage payments. A mortgage payment is a payment on a loan and not a payment of housing costs. As such, it is not a qualified higher education expense.

Even if you could, using a tax-free 529 plan distribution to make mortgage payments would prevent the taxpayer from claiming the home mortgage interest deduction. IRS coordination restrictions prevent taxpayers from claiming two tax breaks based on the same expense.

If the student owns the home, it may affect the student’s eligibility for need-based financial aid. The Free Application for Federal Student Aid (FAFSA) provides an exclusion from assets for the parent’s principal place of residence [20 USC 1087oo(d)(2)(B)] and an independent student’s principal place of residence [20 USC 1087pp(c)(2)(B) and 20 USC 1087qq(c)(2)(B)], but there is no similar exclusion for a dependent student.

What If the Child Pays Rent to the Parent?

A possible workaround is for the child to pay rent to the parent, which the parent then uses to make the monthly mortgage payments. However, since the parent must report the rent as income on their income tax returns, it counters the tax benefit of using 529 plan money to pay the rent.

The rent must be based on the fair market rental value of the real estate. This is necessary not just to use the student’s 529 plan money to pay the rent, but also for the parent to deduct rental expenses from the rental income. There are complicated tax rules that apply when the taxpayer rents property to relatives.

If the rent is less than the fair market rent for the property, the parent’s ability to deduct rental expenses from the rental income will be limited. Likewise, the student must use the property as their primary residence. In particular, rental expenses may be deducted only up to the amount of the rental income. Excess rental expenses cannot be carried forward to the next year.

If the student who has roommates who pay rent, that may be an indication of fair market rent. The parent can charge the student the same rate as the roommates.

However, it is better to base the rent on a rental survey for properties of similar size, location and amenities. The college housing office may have such a rental survey available.

The student and parent must formalize the rental agreement with a lease.

Note that the parent cannot give the child money to help them pay the rent, as then the net amount of rent charged will be less than the fair market rent.

Other Limitations on Rent

There are two additional limitations on rent.

  • Capped at amount specified by the college. The rent paid by the student is considered a qualified higher education expense only not exceed the allowance for room and board for students who live off campus. This allowance is specified by the college in the college’s cost of attendance (sometimes called a “student budget”). (This allowance is higher than the allowance for students who live at home with their parents.) Distributions from a 529 plan that exceed the student budget allowance will not be considered qualified distributions.
  • Half-time enrollment required, including during the summer term. The student must be enrolled on at least a half-time basis for rent to be considered a qualified higher education expense. In particular, if the student is not enrolled in classes on at least a half-time basis during the summer term, the rent paid for the summer months is not considered to be a qualified higher education expense. The parent cannot bypass this restriction by waiving the summer rent, as otherwise the rent will be less than fair market rent.

Rental Income Must Be Reported on Tax Returns

Although having the student pay rent to the parent allows a tax-free distribution from the student’s 529 plan, the parent will have to report the rent as income on their income tax returns.

If the student pays fair market rent and uses the real estate as their primary residence, the parent may deduct rental expenses from the rental income. Rental expenses include utilities, mortgage interest, property taxes, insurance, maintenance, repairs, HOA dues, condo fees and depreciation. However, even if depreciation may offset income, the depreciation will be recaptured when the property is sold.

In most cases, the parent will pay more in income taxes by charging their child rent and using a 529 plan distribution to pay the rent. The full amount of rent (minus rental expenses) is taxable income to the parent. A qualified distribution from a 529 plan avoids having to pay income tax (and a 10% tax penalty) on the earnings portion of the distribution.

A good place to start:

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