Can I Buy a House and Pay My Mortgage with 529 Plan Money?

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Mark Kantrowitz

By Mark Kantrowitz

March 27, 2024

Some parents purchase a property near a college campus to provide their children with off-campus housing while enrolled, saving on room and board costs. 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 the money from a tax-advantaged 529 plan to pay the monthly mortgage bills?

Mortgage Payments Do Not Qualify as Room and Board

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

Even if the student were to buy the home, they still can’t use 529 plan funds to make the mortgage payments. A mortgage payment is a payment on a loan and not a payment of housing costs. As such, it would be treated as a non-qualified expense.

Even if you could, using a 529 college savings plan distribution to make mortgage payments would prevent the taxpayer from claiming the home mortgage interest tax deduction. IRS coordination restrictions prevent taxpayers from claiming two tax breaks based on the same college 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)]. Still, 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. Complicated tax rules 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 until next year.

If the student has roommates who pay rent, that may indicate 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 the net amount of rent will be less than the fair market rent.

Other Limitations on Rent

There are two additional limitations on rent.

  • Capped at the amount specified by the college. The rent paid by the student is considered a qualified higher education expense only if it does 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 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 is required, including during the summer term. The student must be enrolled at least half-time for rent to be considered a qualified higher education expense. In particular, if the student is not enrolled in classes at least half-time during the summer term, the rent paid for the summer months is not considered a qualified higher education expense. The parent cannot bypass this restriction by waiving the summer rent; 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 federal income tax (and a 10% tax penalty) on the earnings portion of the distribution.

A good place to start:

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