529 Plan to Invest in Real Estate

[a1herp]

I will be a college sophomore next year and I currently am on a full scholarship to attend university. My parents have a 529 plan for me and are using that to pay for my rent at my off campus apartment. I want to buy a property and use that 529 plan money to help pay for the mortgage instead of the money disappearing. My parents are fully on board with this idea and will co-sign and help with a small percentage of the down payment. I’m aware I can’t use this money to help fund the downpayment but since I’m a first time home buyer I would get an FHA loan and put down less than 20%.  

I understand the 529 can’t be used to pay the entire monthly mortgage payment, but if I put the property in my LLC, can I put myself on a lease and charge rent to myself and my other roommates without getting a penalty from the 529 plan? 

Or would it be smarter to have my parents own the property and charge me rent which can then be paid by the 529 plan?

My parents want to reward me with some of the money in the 529 plan for receiving a full scholarship. My whole idea is to avoid paying the penalty fee from the 529 plan and I want to be the primary home owner. Any suggestions to go about this or if this is even legal? 

[Hal_Al]

Off campus housing and food are eligible expenses for a 529 distribution, but the amount is limited to the lesser of your actual cost or what the school charges on campus students for R&B (technically the school's "allowance for cost of attendance" for financial aid purposes).

References:

https://www.glassjacobson.com/blog/529-off-campus-housing/  

http://turbotax.intuit.com/support/iq/Education/Information-about-Form-1099-Q/GEN12272.html

So, it basically doesn't matter how you and your parents  structure the ownership of the real estate.  Your tax free (if any) and penalty free distribution amounts will be limited to the "allowance for cost of attendance" and scholarship numbers. 

[Carl]

While I can't state for sure, this has the potential to affect your qualification as a dependent on your parent's return if the property deed and/or mortgage is in the student's name. Just be aware of that. There also may be other factors affecting education expense deductions that I'm not aware of.

[NCperson]

@a1herp - here is another idea..... under Secure 2.0 (and the rules are still being worked out), unused 529 money can be flipped into a Roth IRA without penalty.  There is a $35k lifetime limit plus other rules.  worth looking into if your parents want to reward you for the scholarship. 

[Hal_Al]

KIPLINGER

BY ERIN BENDIG

PUBLISHED 24 FEBRUARY 2023

529 Plans Get a Boost With Tax-Free Rollovers to Roth IRAs

You’ll soon be able to roll over funds from your 529 plan into a Roth IRA, thanks to recent legislation.

Maybe you had a child change their mind and not go to college or you saved more than necessary, and now you’re wondering what to do with the cash locked away in your 529 plan. Thanks to the SECURE 2.0 Act, you’ll soon be able to roll over funds from your 529 plan into a Roth IRA, as long as certain conditions are met. Here’s what you need to know about the new changes set to go into effect next year.

What are the new tax rules for 529 plans?

The SECURE 2.0 Act contains numerous changes to retirement-related provisions. Under Section 126(opens in new tab) of the act, the Internal Revenue Code is amended to allow tax-free rollovers from 529s into Roth IRAs under certain conditions. By rolling over unused funds from a 529 account into a Roth IRA, individuals will now be able to avoid income tax and tax penalties that occur when withdrawing funds for non-education expenses. For this reason, we may now see more families opening 529 savings accounts.

Section 126 of the SECURE 2.0 act reads, ”Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education. They should be able to retain their savings and begin their retirement account on a positive note.”

How Much Can Be Rolled Over?

There is a limit on how much money you will be able to roll over from your 529 plan to a Roth IRA. The limit for beneficiaries of 529 college savings accounts to roll over to a Roth IRA is $35,000 over the course of their lifetime. However, these rollovers are subject to Roth IRA annual contribution limits. IRA contribution limits for the 2023 tax year are $6,500 for people under 50, and $7,500 for people 50 and older.

When does the 529 plan rollover start?

The 529 plan to Roth IRA rollovers will go into effect on January 1, 2024. 

What are the limitations on 529 plan rollovers?

While the ability to rollover funds from your 529 plan to a Roth IRA can be beneficial in some cases, there are a few limitations.

Your 529 savings account must be open for over 15 years before funds can be rolled over into a Roth IRA. 

If the 529 beneficiary is different from the 529 holder, the Roth IRA must be in the beneficiary’s name. 

529 contributions made within the preceding five years cannot be rolled over.

The lifetime maximum that can be rolled over is $35,000.

Beneficiary must have earned income that year

https://www.kiplinger.com/retirement/retirement-plans/529-plans-get-a-boost-with-tax-free-rollovers-...

https://www.journalofaccountancy.com/news/2023/mar/saving-college-new-529-to-roth-irs-transfer-rule.....

[Hal_Al]

Another issue:  scholarships that pay for tuition, fees and course materials (QEE - qualified educational expenses) are tax free.  Scholarship money  that pays for living expenses (e.g. room & board), whether on campus or off, is taxable income to the student.  So, if your "full scholarship" also pays for room and board (R&B), that portion of of your scholarship is not tax free. As such, a 529 distribution, for R&B, up to the "allowance for attendance" amount, is tax and penalty free, since it was not paid for by "tax free" scholarship.

Back to your original question, anyway you structure it will  qualify. You mortgage interest, as well as utilities, insurance and real estate tax,  would count.  Rent paid to your parents would count. Just living in a home owned by them would count.

"Rent" or shared expenses, paid by room mates, would reduce the amount your could claim. But, that's mostly academic, as your net amount is still likely to be more that the school's "allowance".