529 Plan Qualified Expenses: Using the 529 to Pay Off-Campus Rent
Published on July 27th, 2016
By Jennifer Oppriecht
A 529 Plan is an ideal way to save for higher education costs. But can you use funds from your 529 plan to pay your off-campus rent? We tapped into an advisor from the accounting firm of Baker Tilly for some guidance on 529 plan qualified expenses.
The Internet is loaded with articles on 529 plans, and ideally the best advice you can receive will come from an accountant. In this post, we’ll provide you some general interpretations of how 529 plans work in regards to rent, including this interview with Mark Smith, Partner at Baker Tilly.
Listen to the interview, and then read on for more details.
What is a 529 plan?
A 529 plan is a tax-advantaged savings plan. Legally referred to as “qualified tuition plans”, the plans are sponsored by states, state agencies or educational institutions. Earnings in plans are not subject to federal tax, and in many cases, state tax, provided you use withdrawals for eligible college expenses, such as room and board.
“Eligible expenses” is the key term here. If you do not use the money on an eligible college expense, you may be subject to income tax and an additional 10% federal tax penalty on earning.
What are 529 plan eligible expenses?
529 qualified education expenses are generally those expense that are required for enrollment or attendance at an eligible institution and fall into the following areas, as noted in this article by Fidelity and explained in the chart below. Again, for more detail, refer to your accountant or IRS publication 970:
Does the rent you pay for your off-campus apartment count as an allowable 529 plan expense?
That amount cannot be more than the greater of the following two amounts:
- The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
- The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
In essence, if you live off-campus, you cannot exceed the school’s estimates for room and board if you lived on-campus. You’ll need to check with the schools to get those estimates or allowances noted above.
What about food and utilities?
Food counts under the room and board and is a qualified expense. Again, you need to be within the allowance as determined by the school. For example, take a look at your school’s total meal plan and room cost.
Any food that you buy needs to fall within the total sum of whatever that board cost. If the meal plan cost for the semester is $4k, you basically have $4k to spend on food. You’ll need to keep track of these meal costs for tax purposes, as explained later in the post.
PRO TIP: Utility costs can be included, as they are part of the room fees. Routine bills such as electric, gas and any type of garbage or sewer and water bills would count.
In total, your reimbursements or payments from the 529 for off-campus rent, utilities and food cannot exceed the allowance provided by the school or you will be subject to taxation on the excess.
How do I make the 529 withdrawals?
According to Mark Smith, you would first contact the financial institution that is handling your 529 plan — be it EdVest or one of the many other plans set up across the country — or the accountant or financial advisor that is handling your funds. This can be handled online most of the time.
The financial institution will generally give you a choice of paying the educational institution directly or reimbursing yourself for an expenditure you made. The organization handling the 529 funds will make a distribution in the form of a check.
If you are paying off-campus rent or utilities; paying for food; or purchasing a computer, have the financial institution reimburse you by issuing the distribution check to you for your use in paying the expense.
You may also be able to have the financial institution set up regular monthly distribution checks for your recurring items like rent and issue the check to your landlord. Again, this will create a better record for you.
As both the 529 plan owner and beneficiary could request and receive checks, consult with your accountant, to determine which party should receive the distribution to maximize tax benefits.
Do I have to report 529 plan distributions on my taxes?
The financial institution — we’ll use EdVest as an example — then reports the total of all of the distributions was made to the IRS. This is reported on a Form 1099-Q, which reports the amount of the distributions (but not the detail), the portion of the distribution that came from earnings in the account, and the portion that was a return of the original contribution.
You will need to have kept records of all of the expenditures you made because you will have to compare the total of those financial institution’s distributions to the total of what you spent on the “qualified educational expenses.”
If you spent all of the distributions on qualified expenses you will report this in your income tax return at the end of the year, but there will be no tax consequences.
Do you have to pay tax on 529 plan withdrawals?
Generally you don’t pay tax on the withdrawals or on the earnings. The gains accumulate tax-free. However, according to Smith, if the distributions exceeded the expenditures on qualified education expenses (as discussed above), you must report that excess as “other income” in your tax return. Check the instructions for your tax form to determine the proper line to report this on.
Also, make sure you get reimbursed for an expenditure in the same calendar year you made the expenditure, or if you are getting a distribution before you make the purchase, make that purchase in the same calendar year you received the distribution.
Otherwise, you may have a mismatch of distributions reported to the IRS against the expenditures you made that year and it may result in an excess you might have to pay tax on. Having the financial institution make payments directly avoids that timing issue.
On pages 59-62 of 970, the IRS notes the important points about qualified tuition programs, and it walks you through a worksheet calculation to determine any taxable portion of a distribution.
You should contact your accountant if you’re uncertain about the expenses.
Do I have to keep records of the receipts?
Smith recommends keeping records of qualified expenditures, particularly if you’re paying rent off-campus. In today’s day and age, this may seem to be a daunting task, especially when everyone pays with debits cards and people tend to discard receipts.
However, you can retain account statements which show the expenditures. This is “especially important when you’re claiming some sort of benefit on a tax return,” Smith said.
If it’s an automated statement, you should have documentation that shows what the withdrawals are for, and then retain the monthly bank statement showing the withdrawals have been made. Be sure to also keep utility bills — anything that can be counted as a qualified expense.
Smith recommends keeping the records for up to 7 years, as you are subject to an IRS review for up to 6 years.
Helpful hint: You can store electronic copies of the receipts on a Google drive in a PDF format. That way, all your records are backed up to the cloud.
Can I use my 529 plan to pay for room and board if I am going to an online college or a beauty school?
We found little guidance from the IRS in terms of using funds for your 529 plan to pay for room and board if you’re attending college online.
It appears that if a college offers online education and a room and board option for students who live on-campus, then you should be able to apply the same criteria that you use for paying rent, utilities and food from your 529 plan that we described above.
However, we could not find any information on whether rent, utilities and food become eligible expenses if your online school does not offer any type of housing. Check with the online school for more details, as well as your accountant.
If you have other forms of financial aid, you may want to consider using those dollars on rent, utilities and food and use the 529 dollars on tuition.
Be careful you don’t “double up” with your tax credits
Smith notes that a student needs to be careful when taking advantage of the various education tax credits that can be claimed.
This will require some planning, as your eligible qualified education expenses for 529 reimbursements should be reduced by the expenditures you plan to claim for the education credit.
Reporting is Your Responsibility
As Smith notes, our tax system is in many respects based on a system of honest reporting. Short of an audit, the IRS has no mechanism to verify the allowable 529 expense you are reporting.
However, playing by the rules with the IRS is highly advised. If you don’t conform to the guidelines listed above, and report accurately what your expenditures include, you risk an audit. And you certainly don’t need that.
The whole point of the 529 is to give you a tax advantage to pursue your education, and help you spend your money on the items ideally suited to further your growth. Follow the guidelines above, and paying for your rent and other expenses won’t be a problem.
Disclaimer: The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments. Baker Tilly refers to Baker Tilly Virchow Krause, LLP, an independently owned and managed member of Baker Tilly International.