529 Plan options?

Question

Here's a 529 plan question for the tax gurus...

I setup a 529 college savings plan for my youngest years ago. She now is in college and earned a full scholarship, so she doesn't need the 529 plan funds for her undergrad expenses. She recently decided to get an off campus apartment with a room-mate, and works part time to make her half of the rent payment. So, finally to the question... Can the 529 plan fund her off campus apartment rent payments? If so, this would free her earned cash up to save for a down payment on RE. Essentially, providing her a means for swapping the 529 plan money out of the fund (without penalties) so she can invest her earned income. I haven't called my CPA yet due to the holidays, just thought I'd ask for opinions before I call and ask tomorrow.  If not, no biggie, she can always wait and use the 529 plan for grad school.

Steven Hamilton II · Answer

A quick tidbit from my tax research service: 
When is room and board a qualified education expense?
Qualified education expenses include room and board in the following situations:

Room and board expenses incurred by students who are enrolled at least half-time at a qualified educational institution are qualified education expenses for:

Education savings account (ESA or Coverdell) distributions 
Qualified tuition program (QTP or 529) distributions 
Student loan interest deduction 
Early IRA distributions 
These expenses cannot be greater than the allowance for room and board determined by the school or the actual amount charged for the institutional-owned housing.

In addition, room and board for an elementary or secondary school may be included as a qualified education expense for an ESA distribution. To be considered a qualified education expense, the room and board must be required or provided by the school in connection with attendance or enrollment at the school.

Room and board is not a qualified education expense for any other credit, deduction, or exclusion.

Publications
970

Code & Regulations
221(d)(1), 222(d)(1), 529(e)(3)(B), 530(b)(2), 530(b)(3), 1.25A-2(d)

Other References

Thom H. · Answer

Great information Steven. Thank you very much for this additional info. I will definitely check further with my accountant. Much appreciated.

Steven Hamilton II · Answer

Oh and Thom H.,

Don't forget this little bit of information:

Additional Tax on Taxable Distributions

Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income.

Exceptions.   The 10% additional tax does not apply to distributions:
Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.

Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

Included in income because the designated beneficiary received:

A tax-free scholarship or fellowship (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),

Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),

Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), or

Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.

Made on account of the attendance of the designated beneficiary at a U.S. military academy (such as the USNA at Annapolis). This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U.S. Code) attributable to such attendance.

Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit (see Coordination With American Opportunity and Lifetime Learning Credits , earlier.)

Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment.

This means she can pull out money to the full amount of the scholarship.  She doesn't not have to pay tax on the earnings portion due to receiving the scholarships.

So she can pull out: the scholarship total, room and board, other necessary expenses. and is eligible to take all of those out from the account. The earnings will be taxable; however, you will not have to worry about a penalty on the earnings.

-Steven

Thom H. · Answer

Thanks Steven. A good point. We'd already considered this and intended to go in that direction, if and when the grand babies start showing up (none at this time!) The current option of removing some expenses for rent will help her with saving her earnings for a down payment...a reward for gaining (and maintaining) the scholarship. She is very interested in getting involved in RE, and understands cash flow and the value in starting early.  (Wish I'd had the opportunity to finish college with no debt and a duplex in my name! She's well on her way!)

Steven Hamilton II · Answer

Thom H.,

If there is anything that she is not using it might be wise to consider using that to pass on to a new beneficiary. I don't know if you have any grandchildren yet; however, it can be used for private schooling and such for them as well.

-Steven

Thom H. · Answer

Thanks for the additional information folks. After speaking with my accountant, she reiterated Steven's input that it would be a qualified expense up to the equivalent allowance for R&B for the institution, provided she is at least a half time student. Steven, as always, great input. Thank you for the information. This is a great option for her to save her earned income for her first RE investment, while utiliziing her 529 and Coverdell monies to cover her rent.

Callum K. · Answer

Informative!  Thanks for clarifying Steven Hamilton II

Marc Bodinger · Answer

Hey Thom H. I agree with Callum K. in that 529 funds can be used for textbooks, computers, probably even meal plans as long as the funds are related to education.

Thom H. · Answer

Steven and Callum,
Thank you both for the responses. I will be discussing with my tax folks today. My assumption was similar to Steven's, that since the cost of rent is equal to room and board for the university, this cost could qualify.  I will verify before any steps are taken, but I have to give my 20 yr old a lot of credit either way for a great idea to enter the RE world. She's already on the right track and thinking outside the box by looking to get ahead and wanting to build equity in her own place.  Thanks again for your responses.

Steven Hamilton II · Answer

Thom H.,

This is a good strategy to consider.

Here is some information on the expenses: 
Qualified Educational Expenses

For purposes of a qualified tuition program, qualified educational expenses include the cost of tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. These expenses also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student.

In order to qualify for tax-free distributions from the QTP, the costs of room and board cannot be more than the greater of the allowance for room and board as determined by the educational institution for financial aid purposes, or the actual amount charged, if the student is living in housing owned or operated by the educational institution.

In other words however much room and board would cost her on campus that is an eligible deduction. I recommend that you keep records of what the costs would have been.

Here are a couple links to the IRS QTP guide. This will tell you what is and isn't allowable.

http://www.irs.gov/publications/p970/ch08.html#en_US_2011_publink1000178534
http://www.irs.gov/publications/p970/ch08.html#en_US_2011_publink1000178566

Callum K.,

See above.

-Steven C. Hamilton II EA

529 Plan options?

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