The room at college doesn’t have to be an expense. It can be a real estate investment and a tax break, with the potential for income and capital gains. It also might be a way for parents or grandparents to acquire a retirement home or second home. You can get these benefits by employing Estate Planning strategies to purchase a place for your grandchild or child to live in while at student instead of renting an apartment or dorm room.
There are several reasons to consider buying housing near the college. A number of real estate markets have softened, making it easier to be a buyer and perhaps find a bargain. In addition, college towns tend to be some of the most stable and profitable real estate markets. Most are fairly immune to trends in the broader economy. Mortgage rates still relatively low. With all these factors, it can make sense to build equity instead of writing a check to the college for room and board or paying rent to a landlord.
There also are nonfinancial benefits. The student gets to select the roommate or roommates. The student also can be in charge of managing the property. This helps the student mature and also might net some tax or financial benefits.
Sorting out the tax issues can be a little tricky, but doing so often is worth the trouble.
In the simplest case, you buy a one bedroom condo for the student. You don’t charge rent of course, but let the student live there and take care of the place. Then, you might be able to deduct the mortgage interest if it is a second home for you and the mortgage is no more than $100,000. The real estate taxes also would be deductible. Other expenses are not deductible. The rental value of the unit might be a gift to the student, but up to $11,000 of rental value qualifies for the annual gift tax exemption. The exemption is $22,000 if a married couple gives jointly.
Most college real estate is larger than a condo and has multiple bedrooms. These properties allow the student related to the owner to live in one room while the other rooms are rented. The owner has a rental property with the potential for income and tax shelter.
In this situation, the most common tax treatment is that the student’s room and a pro rata portion of the common area overhead and expenses are treated as personal use of the owner. This is so because the owner is allowing the student to use the property without paying rent. The rest of the property is treated as a rental property. The owner can deduct from the rental income a pro rata portion of mortgage interest, depreciation, property taxes, repairs and maintenance, insurance, and other expenses.
If the rental income minus deductible expenses results in a loss, the loss might be deductible against other income. If adjusted gross income before considering the rental property is below $150,000, the rental loss can be deducted against other income. If AGI is higher, the rental property is a passive activity. Losses can be deducted only against income from other passive activities. Unused losses are suspended and can be used in future years against passive income from the property or other passive activities.
An aggressive position would be to name the student as manager of the property with responsibilities such as collecting and depositing rents and arranging for repairs and maintenance. Then, the student’s room is compensation for the management duties. That can make the entire property a rental property so that all the expenses can be deducted against rental income.
Free IRS Publication 946 gives all the details on depreciation and Publication 527 explains the rules on renting residential property. Download from the web site at www.irs.gov or call 800-tax-form.