Tax Strategy for College

Tax, SDIRAs & Cost Segregation
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Tax Strategy for College

Martin Silverstrim
Rental Property Investor · Member since 2019 · 22 posts · 2 votes

I'd like to pose a question to the group that's been on my mind. I'm probably getting ahead of myself. Part of my plan is to do something like Brandon did and purchase a rental property that will help fund my kids' college starting 15 years from now. I dont plan on it being my only property. I have no problem purchasing as a family w my wife, but wondering whether I should consider putting it under an LLC for tax purposes. I dont plan on selling anything I buy unless I have to, but I worry about owning it as an individual and being seen as MY asset rather than being sheltered through an LLC. My real goal is to have a few properties or units (between 10 and 20) by the time my kids are 18 (and I'll be 60!) to supplement my pensions and 403b. I just dont want my kids to get no financial aid bc mom and dad own numerous properties; we have 529s for both kids already, but I'm divesting my taxable investment accounts to fund my first deal when that comes along. I know we need to consult an accountant/CPA, but I was hoping to get an idea through BP prior to moving forward. Either way, I plan to move forward in the next 90 days, but dont want any surprises down the road.

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Eamonn McElroy
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
7y

I don't really see how one rental is going to pay for college...unless put it on a 15 year mortgage and sell it when they start. Those taxes will hurt however and you need to take that into consideration on your ROI calc.

A portfolio of 10-20 with paid off mortgages would probably work.

And if you have a portfolio of 10-20 with paid off mortgages by the time they start should you really be worried about financial aid?

@Caleb Heimsoth

Agree that it should be ROI driven. Depends on what ROI you get with the rental vs what you get in the 529.

Most states will give a tax deduction for 529 contributions, up to a point, and there's no tax on withdraws for qualified educational expenses.  529s are certainly even more compelling under the TCJA with the expansion of use to K-12.

Forget college, all parents with kids in private K-12 should be examining using a 529 as a "conduit account" at the bare minimum to get the state tax deduction.

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  • Scott P.
    Rental Property Investor · Indiana...mostly · Member since 2019 · 468 posts · 245 votes
    7y

    Congrats on thinking and planning ahead! Yes, consult your professional CPA et al.  There are people in those businesses who are even happy to give no cost advice - in order to set up a "relationship" with you so that they could offer add'l services in the future, some of which require a prior relationship.  In the meantime I can tell you what I did since I'm 20+ years ahead of you....

    My initial rentals were owned in my state as a Sole Proprietor.  My plan was to have 1 per child to help pay for college.  Each was on a 15 year mortgage.  All those were paid in full by the time the oldest started college.  They were considered as "Assets" on the FAFSA, not a "Small Business" - which is treated much better on the FAFSA.   If you're the kind of person who has a 529 and who's asking this sort of question on BP, I highly doubt you'll get any aid at all no matter what you do.  (If you can remember 15 - 18 years from now, I'd be curious to know if I'm correct ;-)

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  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Martin Silverstrim. The 529 plan is way better then the Brandon turner buy a rental plan. I’d stick to just to 529 and have your rentals fund your retirement

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    I don't really see how one rental is going to pay for college...unless put it on a 15 year mortgage and sell it when they start. Those taxes will hurt however and you need to take that into consideration on your ROI calc.

    A portfolio of 10-20 with paid off mortgages would probably work.

    And if you have a portfolio of 10-20 with paid off mortgages by the time they start should you really be worried about financial aid?

    @Caleb Heimsoth

    Agree that it should be ROI driven. Depends on what ROI you get with the rental vs what you get in the 529.

    Most states will give a tax deduction for 529 contributions, up to a point, and there's no tax on withdraws for qualified educational expenses.  529s are certainly even more compelling under the TCJA with the expansion of use to K-12.

    Forget college, all parents with kids in private K-12 should be examining using a 529 as a "conduit account" at the bare minimum to get the state tax deduction.

    2Reply
  • Martin Silverstrim
    OP
    Rental Property Investor · Member since 2019 · 22 posts · 2 votes
    7y

    @Scott P. Thanks for the response. I'm just trying to strategize a little early in in the process. My kids will be entering college as I am eligible to start collecting my national guard retirement. I'll probably keep working on some level then, but I hope to be financially free by then. When it comes down to it, I think I do just need to start talking to CPA s and financial planners. My taxes have always been suoer simple up until now. I'm good on the 401k front, but feel like I should be diversifying more w real estate and take the chance that I might actually be able to develop enough passove income that I can walk away from my w-2 job by the time I'm 50 or so.

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  • Martin Silverstrim
    OP
    Rental Property Investor · Member since 2019 · 22 posts · 2 votes
    7y

    @Caleb Heimsoth thanks. We're continuing to fund the 529 plans for both kids. I'm just thinking worst case scenario= 2 kids@100k per year for college x 4 yrs. We're prob better off than I think though...i have almost 2yrs of my GI bill that I didnt use, so its more like 6 yrs to fund. Id like to have something I can use as an additional funding source either through rental income or possible future sale if needed.

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  • Martin Silverstrim
    OP
    Rental Property Investor · Member since 2019 · 22 posts · 2 votes
    7y

    @Eamonn McElroy youre right. Hopefully we wont have to worry about financial aid. If they don't get aid and its just annoying they didnt get any but I can swing it, I'll be ok w that. Kids will contribute some to their own Educations.

    I'm hoping that sticker price will remain true...its not what you actually pay. Between GI bill from me, scholarships, grants, 529s, kids loans, and some real estate assets, I think we'll be ok.

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  • Sunshine Bizz
    Jacksonville, FL · Member since 2017 · 35 posts · 2 votes
    7y

    @Eamonn McElroy

    Thank you for sharing feedback, this was my approach too for the kids. I have $250k houses for both my kids who are 8 and 6 when i bought the houses. 

    Our Math - Paid $240k, current market is $280k, we pay these down next 10 years and have enough equity in each home. 

    Question - How is this a bad strategy for providing for college for kids?

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  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Sunshine Bizz. It’s not a bad strategy but you’re not diversified. If the real estate market tanks, you lose all that value. What I’d do is just fund the 529 plan, stick it in the s and p 500 index fund and let it sit for the next 15-18 years. Likely you’ll have overfunded their college education if you do this. But this is a real estate website so naturally most people will probably disagree with this

    1Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Sunshine Bizz. Also real estate is highly illiquid. What if you can’t sell the house when you need to? The stock market is highly liquid. You sell and get your money in several days. This won’t happen with a house. Again just my opinion

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  • Sunshine Bizz
    Jacksonville, FL · Member since 2017 · 35 posts · 2 votes
    7y

    Thank you 

    @Caleb Heimsoth for your feedback. Agree, ups and downs happen. 

    From a tax / net income which strategy is better?

    - Me cashing in the equity in 15 years and realizing the gain that will go to my kids?

    or

    - S&P Vanguard 500 fund and realizing the gains?

    Any input will be ideal around the tax implications and kids college future

    1Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    7y

    I pay mine for working at our rentals and fund a Roth for them. Minor children can earn up to  $6500 without even filing a 1040. Mine's a 401 Dad.  I put whatever they earn for the year in Roths as a 100% match. They have bank accounts with that amount in them for proof of earning.

    If your kids are 3 or real young  that's tougher, but wanted to share the idea. @Brandon Hall wrote a blog piece on it.  Because Roth contributions can be withdrawn penalty-free after 5 years, the kids will have access to those and completely flexible to spend on whatever.

    My boys are also members of 2 apt building family LLCs but I wouldn't try to have minors as owners. Here they cant even own a car until 18. Cant sign any cotract until 18 etc. Check your state age mins to be LLC members.

    Like anything in RE, don't over-complicate or limit.  A 529 would not be my favorite by a long shot.  Try and get money into something more flexible like an ESA, UTMA or Roth. 

    1Reply
  • Audrey X.
    Rental Property Investor · Atlanta, GA · Member since 2018 · 41 posts · 29 votes
    7y

    @Martin Silverstrim

    Hi Martin, unless you're buying in cash, I haven't found any conventional lenders who would finance a house to a LLC. I know some folks say you can deed it to a LLC after closing and not tell the lender, but that would give the lender the right to declare default, if and when they choose, and that's too big of a risk for me personally. Commercial lenders will finance to a LLC but the rates are horrible.

    I don't know where you live but the transactional cost of maintaining a LLC is also a factor you need to consider. If you live in a state that's cheap to form a LLC and cheap to maintain it each year (annual registration fees etc), then it may be worth it assuming you can get around the lender issue.

    If you can, diversify like what the others said. In my experience, the stock market has not really given great returns in the past 10 years even though we've had a bull market. The compounding thing hasn't really played out for my portfolio and I invested in index funds. So I wouldn't bank on that S&P 500 for 15 years. You'll be lucky if you get an average 4% return over 15 years. I think the real value of 529 is being able to save tax free and grow tax free, and if your State allows a deduction, you get an extra tax benefit.

    In contrast, my real estate portfolio has done far better in cash flow and equity the past 10 years. I plan to use the equity in real estate and 529 to fund my kid's college fund.

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  • Audrey X.
    Rental Property Investor · Atlanta, GA · Member since 2018 · 41 posts · 29 votes
    7y

    @Eamonn McElroy

    You don't sell the house, you get A HELOC or do a cash out refinance. 100% tax free and you keep the property. The rates of a HELOC and cash out refinance are much lower than what the student loan interest rate is. It can work with one property in 15 years if the numbers are right.

    1Reply
  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Audrey X.

    "You don't sell the house, you get A HELOC or do a cash out refinance. 100% tax free and you keep the property."

    And what happens if you can't get a HELOC, or your HELOC gets cut?  If you were around during 2008/2009 you'll remember how quickly credit dries up in a recession/depression....

    "You'll be lucky if you get an average 4% return over 15 years."

    4% or less would be the extreme lower end of the range for a 15 year period, not the average.  March 1994 - March 2009 gave 3.3% compounded without considering dividends, and that would arguably be the absolute worst 15 year time period in our lifetimes to invest in the S&P 500.

    Real estate is not without risks either, ultimately this should be a decision for OP and his team -- financial advisor and CPA.

    @Steve Vaughan

    "Minor children can earn up to $6500 without even filing a 1040."

    For 2018, it's actually $12k earned income for dependents who aren't >= age 65 and/or blind.

    1Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y
    Originally posted by @Sunshine Bizz:

    Thank you 

    @Caleb Heimsoth for your feedback. Agree, ups and downs happen. 

    From a tax / net income which strategy is better?

    - Me cashing in the equity in 15 years and realizing the gain that will go to my kids?

    or

    - S&P Vanguard 500 fund and realizing the gains?

    Any input will be ideal around the tax implications and kids college future

     If you’re talking strictly college and you know your kids will go to that, I like 529 with index funds. 

    I also like a lot of what @Steve Vaughan said because it gives you flexibility.  My suggestions just went to funding college.  If your kids don’t go to college or you’re not sure if they will, it’s better to do what Steve is talking about. 

    1Reply
  • Martin Silverstrim
    OP
    Rental Property Investor · Member since 2019 · 22 posts · 2 votes
    7y

    @Audrey Xi. Thanks. I dont' think I need an LLC right now. If things take off, I'll consider it. Part of my issue issue is that I'm looking to OOS due to the high cost of entry into the VT market. We're actively saving for retirement (~20% right now) and putting 5-7K into 529's each year. I do have pensions through my Guard and FT job even if I walk away now (just can't draw on them until 60 or 62). We shouldn't be in a bad position when the time comes based on our current strategy. That said, I'd like to establish the rental property plan. The first property doesn't HAVE to be for funding college, but it seems like a good diversification. I'm reaching out now to get in touch with a real estate CPA...don't want any big surprises on taxes when I purchase my first property.

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  • Martin Silverstrim
    OP
    Rental Property Investor · Member since 2019 · 22 posts · 2 votes
    7y

    @Steve Vaughan. Thanks for all your info. You mentioned a few good considerations like the kids' Roth. Mine are a year and 3 1/2 yrs old, so I have a few years until they can 'work,' but not a bad option. Responsibility and value rolled into one:) I do like Roths. I have my wife doing all Roth (403b and Roth IRA) since she's much younger than me. Hopefully, we won't have to touch her accounts until I'm well past 70.

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  • Audrey X.
    Rental Property Investor · Atlanta, GA · Member since 2018 · 41 posts · 29 votes
    7y

    @Eamonn McElroy

    There's always cash out refinance if there's no HELOC. Ideally, the property will be paid off in 15 years or 75% paid off. Who wouldn't loan money on a property free and clear or close to free and clear? You keep leasing it until that money is paid back by your tenant and you still get tax deductions. The RE market is never going to crash like it did in 2008. Plus, the stock market crashed in 2008 too so it's not like your investment is safe there depending on the economic cycle.

    Everybody sells the 7% compound interest thing but I haven't seen my index funds grow at an average of 6% in 10 years with the highs and lows in the market. The funds go up mostly because I keep contributing each year. The actual return in 10 years basically kept me above inflation. So I wouldn't bank on those compound interest calculations. Just keep saving money and hope your principal will be there when it's time to withdraw.

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  • Bill F.
    Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
    7y

    @Audrey X.

    I think the point that folks are getting at when they bring up issues with RE illiquidity is that there are certain situations where you could not get your funds out quickly and easily as you could with equities. No one has a crystal ball to predict if and when credit will dry up, but we all know its a possibility. So that's why its a good idea to have options.

    Also, the return for the S&P 500 have been 7.33% for the past 10 years, so you may want to check the fees on your index fund.

    2Reply
  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Bill F.

    That figure is inaccurate.  Try 14.0% compounded excluding dividends and 16.3% compounded reinvesting dividends.

    March 2009 was the bottom of the market during the subprime bubble so those returns make sense.

    https://dqydj.com/sp-500-return-calculator/

    2Reply
  • Bill F.
    Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
    7y

    @Eamonn McElroy That's the calculator I was looking for! 

    I stand correct and thanks for posting the link. I'm book marking it this time.

    1Reply
  • Caleb Heimsoth
    Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
    7y

    @Eamonn McElroy. Pretty hefty returns. I think assuming 7-8 percent return annually long term is a pretty safe bet. I know investors who have averaged more then 10 plus percent going back almost 30 years, and that includes at least 2 probably 3 recessions

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Caleb Heimsoth

    The longer the time period held, the more your return will converge on the mean of 8% per annum.   To get 4% compounded over 15 years from the S&P 500, you would have to choose the absolute worst 15 year period possible.

    Returns many orders of deviation from the mean come from short holding periods.  We're talking one year, two years, five years max.  Definitely not 15 years.

    1Reply
  • Mark Welp
    Investor/Agent/CPA · Columbus, OH · Member since 2015 · 249 posts · 207 votes
    7y

    @Caleb Heimsoth

    Everybody has their own opinion, but 529 Plans really are not great products; they are a jail for your money and all you get is a lousy state tax deduction. The gov’t will punish you if your child gets a full ride and you don’t end up using it for education. There are a lot better ways to fund college in a tax favored environment than 529s.

    I can share more if need be. Thx!

    1Reply
  • Sunshine Bizz
    Jacksonville, FL · Member since 2017 · 35 posts · 2 votes
    7y

    @Mark Welp Thank you for sharing your feedback. Here is the scenario:

    - Purchased property in 2017 for $240k, put down 20% and rest financed. 

    - 2029 this property is worth about $300k which is possible since it is right now at $280k

    - We pay down the P & I aggressively and in 2029 want to take out $150k for my son to go to college

    Question ---- How does this $150k be taxed? 

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