This is a recent question that came my way:
“We are in the process of purchasing an investment property where my daughter goes to school. Our intent is to use this as a rental. It is located near our daughter’s college and we intend to rent it to her using funds from her 529 to pay the rent. What precautions do we need to take to avoid scrutiny from the IRS?”
This is an excellent question. There is nothing preventing someone from using this strategy as long as you follow the rules concerning distributions from a 529 college savings plan to cover room and board:
- The student must be enrolled at least half-time.
- Room and board expenses are limited to the room and board allowance determined by the school. The limit is determined by each school based on its “cost of attendance” figures reported to the federal government for financial-aid purposes. You should ask the school’s financial-aid office for the relevant room-and-board figure.
You can’t use the 529 plan distributions for a down payment on the property, but you could have distributions help pay the monthly mortgage by using distributions towards rent payments while your daughter attends school. I would have a rental agreement drawn up between you and her (and any other students who may also be renting). Deposit the 529 plan distributions into an account in her name, and make the payments from her checking account. The rent charged should be reasonable; it should reflect the normal market rates where she lives. I would also keep copies of the rental agreement and cancelled checks to prove the payments were made with your tax return file for the year.