Can you pay a mortgage with a 529 plan?



Dear Joe, Can I use a mortgage payment for student housing expense as a 529 plan expense? I would like to purchase a condo near campus for my out-of-state student and pay the mortgage with 529 savings. -- Ross


Dear Ross,

You run the risk of an IRS challenge if you count your mortgage payments as a 529 plan expense. The reason for this is that qualified higher education expenses must be incurred by the student, and in this case you are contemplating a mortgage on property you own yourself.

Instead, your child should pay a reasonable rent to you for living in your condo. The rent payments will pass muster as a 529 expense and can be withdrawn tax-free from your 529 plan. Unfortunately, you would have to report the rent income on your own tax return, but you could then also claim mortgage interest, property taxes, depreciation and certain other costs as rental expenses.

Remember, there is a limit to how much can be withdrawn tax-free from a 529 plan to pay for room and board. The limit is determined by each school based on its "cost of attendance" figures reported to the federal government for financial-aid purposes. You should ask the school's financial-aid office for the relevant room-and-board figure.

Instead of purchasing the condo in your name, consider the alternative of helping your child purchase his or her own condo. This way it may be possible to include the mortgage payments incurred by your child as 529-eligible expenses. This is a gray area, so check first with your own tax professional. Of course, you may have to co-sign on the mortgage if your child cannot qualify for a mortgage on his or her own.

Your child may even qualify for the first-time homebuyer tax credit, worth as much as $8,000. The credit has been extended into 2010, although there are a number of new rules attached to it. For example, the homebuyer must be an individual who cannot be claimed as a dependent on someone else's tax return.

To have any hope of qualifying for the homebuyer credit, there must be a binding purchase contract in place by April 30, 2010, and settlement must occur by June 30, 2010. Your child will have to maintain the property as his or her primary residence for at least three years or have to repay the credit.