Unfortunately, you can't just divide things up in the most convenient way for you. Well, you could. But if audited you would most likely lose. I know people to do it and have never been audited. For them it's no problem. But then, it's my bet that the ones who do what you and then never "get back and let us know" are to embarrassed to admit we were right.
Basically, any scholarship money applied to room and board is taxable. Period.
Grant money that is applied to room and board may or may not be taxable. A grant can be specified as to what that money is for, by the grantor. Sometimes the grantor will specify that the funds can be used for qualified education expenses, as well as those unqualified expenses "directly related to the educational pursuit". Room and board would be directly related to the education. Of course, if the student is going to college in the home town and moves out of mom and dad's house just to get their own place, that's not in direct support of the education. So that could be questioned.
Whereas per the IRS rules, 529 funds can be used for qualified education expenses *and* room and board for the student in direct support of that student's education.
But generally speaking, if the amount in box 5 of the 1098-T exceeds the amount in box 1 or 2 of the 1098-T, then while the parents will claim the student as their dependent if they qualify, it is the student that will report all the education stuff on the student's tax return. The parent's will report nothing past claiming the student as a dependent. But you already know this of course.
bottom line is, the IRS has a certain order in which the IRS applies funding.
- First, all scholarships and grants are applied to qualified education expenses. (room and board is not a qualified expense). Then if there's any excess it's taxable income to the student.
- Next, 529 funds are applied to qualified education expense if not all covered by scholarships/grants. Then any remaining 529 funds are applied to the unqualified but allowed room and board expense. After that, any excess is taxable income to the student.
- At this point, if all qualified expenses have not been paid in full by scholarships, grants and/or 529 funds, then, and only then are out-of-pocket expenses applied. As you know, out of pocket expenses for room & board do not qualify for a deduction of any type.
So if you're trying to shift some of the 529 funds used to pay tuition, to the room and board stuff so you can claim qualified out of pocket expenses, you'll get away with it just fine, until and if you get audited. If that happens, then all the back tax, interest, late fees, fines and penalties will make your manipulated tax savings seem like a pittance in comparison.
