If you’re sending a child to college away from home, be prepared to pay big — and not just for tuition. For the 2007–2008 academic year, the average cost for room and board at public universities is more than $7,400, the College Board reports, up 5.3% from a year earlier. At private colleges, the average cost is nearly $8,600, up 5% from 2006–2007. Those are averages, so some schools are charging even more.
Bottom line: You can expect to spend $30,000 or more for room and board for each child who goes away to college for four years.
Strategy: Buy your child a place to live near the campus. In today’s buyer’s market for housing, you might find a very good deal.
If you sell the property a few years from now, you may get a better price. Even if you just break even on the real estate, you’ll save by not paying for college housing.
What’s more, tax breaks can increase your chances of coming out ahead.
In a simple example, you might buy an apartment where your daughter can live while she goes to school.
Tax benefits: If you itemize, and as long as you’re not subject to the alternative minimum tax, you will be able to deduct the property tax you pay. If you use a mortgage to help finance the purchase, the interest you pay will be tax deductible, too. In essence, the apartment would be taxed as if you were using it as a second home.
Final accounting: When you sell the apartment, assuming that you’ve owned it for more than a year, any gain will be taxed at only 15%, as a long-term capital gain.
Trap: A loss on your sale won’t be treated as a capital loss because you can’t take a capital loss on the sale of a residence, so you would get no tax benefit.
Strategy: Rather than take a loss, you may prefer to rent the apartment, perhaps to a different student, after your daughter moves on. You can receive rental income while you wait for your apartment’s value to recover.
A more ambitious venture is to buy a larger apartment than your child needs or a house near the campus.
Next step: Let your own child live in this residence and rent space in it to one or more other students. Because they’ll pay rent to you, the residence will become income-producing property.
Tax treatment: Operating costs will become tax deductible. That could include everything from utility bills to insurance.
You also will be able to take depreciation deductions for the real estate, furnishings, fixtures, etc.
Management fees: Name your child as property manager. Your child’s responsibilities could include screening tenants, getting leases signed, collecting rents, arranging for property maintenance, and so on.
For those services, you could pay your child a management fee. Approximately 10% to 12% of the rental income received from tenants might be reasonable, depending on other property management fees in the area.
Loophole: Such management fees will be deductible for you, the property owner. They can reduce taxable income from rents or contribute to a loss for tax purposes.
At the same time, income from these management fees probably will be tax free to your child. In 2008, because of the standard deduction, single taxpayers may have up to $5,450 in earned income and owe no tax.
Therefore, this arrangement can be a tax-efficient way to give your collegian spending money.
Travel smart: What’s more, your trips to visit the college town may be deductible if your primary purpose is to check up on your investment property. Note: Be sure to document that you checked on the house’s condition, spoke with the property manager (your child) about maintenance, met with student-tenants to see if they have concerns, researched nearby rents, etc.
Deductions for management fees, depreciation, travel, and other expenses may generate a taxable loss from the property each year. This might be the case even if you have positive cash flow from rental income.
Tax treatment: Such a loss would be considered a passive loss. As long as your adjusted gross income (AGI) is less than $100,000, up to $25,000 worth of passive losses can be deducted each year.
As your AGI goes from $100,000 to $150,000, your maximum passive loss phases out, from $25,000 to zero.
Example: Your AGI in 2008 is $145,000. You are 90% through the phaseout range, so you are entitled to deduct only 10% of the maximum — you can deduct up to $2,500 worth of passive losses.
Say your near-campus housing investment shows a $4,000 loss this year. You could deduct $2,500 in 2008.
The $1,500 that was not deducted can be carried forward to future years. If you have taxable passive income, such as from other rental properties, that $1,500 passive loss can serve as an offset.
End of the deal: When you ultimately sell the property, you can use any passive losses not previously deducted. Those losses can decrease a taxable gain or increase a capital loss from rental property.
Tax benefits will help a near-campus investment, but there is risk in any real estate venture. Some basic precautions can increase your chance of success.
Location: This is always crucial for real estate investing. Look for a place not far from the school in a neighborhood that’s safe and doesn’t seem intimidating in any way. A good location will help make student-tenants and their parents feel comfortable. Moreover, it will make it easier to eventually sell the property.
Tenant tactics: Be cautious about selecting tenants. Get references from employers to see if the students have been reliable. Have the students’ parents sign 12-month leases and provide guarantees that they’ll be responsible for the rent. You may have to give those parents permission to sublet over the summer months.
Bonus: If you get your child involved in tenant screening and other aspects of managing the property, he/she may have some valuable insights to offer…and will probably pick up some valuable life lessons on what it takes to make a profit from a business venture.
