Freshmen to senior year are the typical times our children decide the college they want to go to. Funding your child’s college can be very expensive, and keeps getting higher over the years, especially as inflation continues to increase.
This tax strategy utilizes multiple tax strategies in layers and should be used with a professional.
When it’s almost time to go to college, it is best to choose one as soon as possible in order to utilize this strategy. Their freshman year is the best time but this strategy can be used even after they start college.
Tax Strategy Layer 1
This strategy involves purchasing a rental property close to the college—a rental property with at least four bedrooms. The property should be within a few miles of the college your child wants to be admitted to.
The goal is to rent each room in the property separately to your child’s friends or other college students. Let’s assume there are only four bedrooms, and each room can accommodate two individuals.
Rent the property out to 7 students, plus your child, that is 8 in total, two students per bedroom, and charge them a reasonable rent. A reasonable figure could be about $800 a month per student, or 35% of the monthly mortgage, which could easily rise from there. Let’s assume seven students are paying rent at $800 per month. This means you receive a total of $5,600 monthly.
Tax Strategy Layer 2
Usually, per IRS code, your child must pay the fair market rent as well while living in the rental. However, there is another layer to this strategy.
In the next layer of this strategy, you must employ your child in that business. You can employ your child as the property manager and pay them a reasonable monthly salary, let’s assume $1,000 per month.
Back to our assumption, suppose you are receiving $5,600 from seven students per month and paying your child, as the property manager, $1,000 per month. In that case, at the end of every month, you earn $4,600 from the property because $1,000 goes to your child, which is most times tax-free, depending on other incomes they earn and deductible for you.
Tax Strategy Layer 3
This is one way to reduce your taxable income, as the original amount you earn is less by $1,000, which is non-taxable to your child. Real estate is a peculiar investment because of depreciation.
Depreciation is a dollar-less expense, meaning you don’t spend money each year to be able to have a depreciation expense on your tax return. Meaning, that even though you have a net profit from the rental your tax return will show a loss that can be used to reduce your other sources of income.
Tax Strategy Layer 4
The final layer in this strategy is taking the $1,000 you pay your child as a manager monthly and investing it in a Roth IRA for your child. Currently, that is $6,000 yearly and a great head start to a tax-free millionaire status.
That said, you have $4,600 to support your child’s tuition. Even if you have a mortgage of $2,000, you are left with $2,600 monthly or $31,200 annually for your child’s college tuition.
This strategy is a great one to incorporate with other strategies – like if they already have a Roth IRA or 529 plan – to reduce their tuition fee or, in some cases, make it completely free.