Can You Use a 529 Plan to Buy a House?

A 529 plan is a tax-advantaged savings plan for future education costs, legally known as a “qualified tuition plan.” This savings plan can be used to pay tuition and expenses related to room and board. But can you use a 529 to buy a house?

In this article, we will discuss if (and how) you can use funds from a 529 plan to buy a house, the financial consequences, and how to best use the funds for a student’s room and board.

What is a 529 Plan?

529 plans are a flexible, tax-advantaged way to save for education expenses, making them an attractive option for families planning for future educational needs. Their benefits extend beyond college savings, now including options for K-12 tuition, apprenticeships, and student loan repayment.

While contributions are not tax-deductible at the federal level, earnings grow tax-deferred. Withdrawals for qualified education expenses are tax-free, meaning that funds used for education expenses are essentially taxed at their initial earnings portion. Many states also offer tax deductions or credits for contributions to their 529 plans.

There are two types of 529 plans:

• Prepaid Tuition Plans
  These plans allow you to purchase credits or units at participating colleges and universities for future tuition and fees at current prices. They typically do not cover room and board. Depending on the state, there may be residency requirements for the saver or the beneficiary.
• Education Savings Plans
  An education savings plan is the more flexible of the two options. Parents open an investment account to save for the beneficiary’s future qualified higher education expenses. Qualified expenses include tuition, fees, books, supplies, and sometimes room and board.

Unlike opening a traditional bank account for a child with a 529 plan, the account owner retains control over the funds and can change beneficiaries within the family if the original beneficiary does not need the funds for education. Therefore, 529 plans are considered a parental asset for financial aid purposes, which generally has a smaller impact on student financial aid eligibility.

Can You Use a 529 to Buy a House?

A 529 plan is designed to help parents save for and fund their child’s education (such as college tuition), which is why the funds can only be used without paying capital gains when they are spent on eligible education expenses.

Technically, yes. Account holders are not limited to spending their money only on education options but can spend it on nearly anything they choose. However, there are financial consequences in the form of taxes. So, while you can use 529 plan funds to buy real estate, it might not be the best use of those funds.

What Happens if You Use Money from a 592 Plan to Buy a House?

If you use 529 plan funds to buy real estate, those funds are considered non-qualified withdrawals. Therefore, the earnings portion of the withdrawal is subject to federal income tax (the principal contributions are not taxed since they were made with after-tax dollars).

In addition to income tax, the earnings portion is also subject to a 10% federal penalty tax. If you live in a state that provides a state tax deduction for 529 plan contributions and you take a non-qualified withdrawal to buy real estate:

• The earnings portion of the withdrawal will be subject to your state’s income tax.
• You may need to repay any state tax deductions or credits you received on the withdrawn contributions.

So, while you can use money from a 529 plan, it may not be the best use for those funds. Plan holders should carefully consider and evaluate their tax obligations if they use these funds on any non-qualified purchases.

How Can You Use Funds from a 529 Plan to Pay for Housing Costs?

Funds from a 529 plan are meant to be spent on education; however, as most university students do not live at home, housing costs can be considered qualified expenses. The IRS considers room and board costs as 529 qualified expenses, which means that if used and tracked correctly, you shouldn’t have to pay additional income taxes.

On Campus Housing

The simplest way to use money from a 529 plan to pay for room and board costs is if the child attends college and lives in on-campus housing. The room and board costs are generally considered qualified expenses if the student is living in on-campus housing. You can use 529 plan funds to pay for these costs directly.

Off-Campus Housing (Room and Board)

Paying for off-campus housing with a 529 plan is a little more complicated than on-campus options, but it can still be considered a qualified education expense. To use 529 funds to live off-campus, you must follow some specific rules to ensure the funds are not subject to additional taxes:

• The amount you can withdraw tax-free for off-campus housing is limited to the cost of room and board included in the school’s published cost of attendance (COA) for financial aid purposes. This means you cannot withdraw more than what the school considers reasonable for room and board.
• Account holders must keep and be prepared to provide proof of the housing expense. Keep records of the rent, utilities, and other housing expenses to substantiate the amount withdrawn from the 529 plan. Receipts, leases, and utility bills can serve as proof.

While off-campus housing is a qualified expense, these rules ensure that the student’s qualified expenses align with the college’s cost of an on-campus room. These funds are not meant to fund a lavish student lifestyle while avoiding income taxes.

For example, if the university’s COA lists $10,000 per year for room and board. If the student lives off-campus and pays $9,000 for rent and utilities, you can withdraw up to $9,000 from the 529 plan for housing without incurring taxes or penalties. If the student’s housing costs are $12,000, you can still only withdraw $10,000 tax-free, as that is the limit set by the school’s COA.

Meal Plans

Most universities offer meal plans that can include a spending budget limit and access to dining facilities. When funds from a 529 plan are used to pay for a student’s meal plan, these costs are considered part of the “room and board” expenses.

If the student is living on campus, the cost of the meal plan provided by the school is considered a qualified higher education expense. You can use 529 plan funds to pay for this cost directly. Students living off-campus can still use 529 plan funds for meal expenses penalty-free, but the amount is subject to the same limitation as off-campus housing. The cost of meals should be at most the room and board allowance specified by the school in its cost of attendance (COA) for students living off-campus.

Keep detailed records of meal plan payments or receipts for off-campus food expenses. This documentation will be useful in case of an audit to verify that the expenses were within the allowed limits.

Additional Qualified Education Expenses

Materials used to pay for student academic needs can be paid for using a 529 plan. These expenses can include:

• Books for coursework.
• Supplies such as notebooks, calculators, and pencils.
• Equipment for classwork.
• Computers, peripheral equipment, software, and internet access if used primarily by the beneficiary during enrollment.

Health Insurance

Students enrolled in an undergraduate degree often need health insurance. Unfortunately, health insurance, along with other expenses such as transportation, student loan payments, and general living expenses, are not considered qualified expenses under the 529 plan rules. Using a 529 plan to pay for a non-qualified expense will result in paying:

• Federal income taxes on the earnings portion of the amount.
• A 10% federal penalty fee.
• Potential state taxes.

Alternatives to Using 529 Funds for Real Estate

While 529 funds offer significant tax advantages for education-related expenses, they are not applicable for purchasing real estate without being subject to taxes and penalties.

If you want to buy a house for your college student to live in, consider some alternative options to finance the purchase.

Traditional Savings

Using funds from a traditional savings account is a straightforward and effective way to buy a house. It gives you the flexibility to buy the type of property that works best for your situation. However, these funds take time to accumulate, and it’s often not a feasible option for parents looking to buy a second property.

Investment Funds

Investing in stocks, bonds, or mutual funds can yield higher returns than traditional savings accounts. If you have liquid funds in investments, these can be used to purchase real estate. A second property can be a great way to diversify your investment portfolio while providing housing for a college student.

Mortgage Loans

Most property buyers use home loans (mortgages) to purchase real estate. Buyers still need to be prepared to make a significant down payment. If you already own property, a home equity loan allows you to borrow against the equity you have built up. This can be an effective way to finance additional real estate purchases, or it can be used to cover the down payment amount.

Unsecured personal loans can be used for home purchases, although they typically come with higher interest rates than mortgage loans. They can be a viable option for smaller real estate investments or if you need additional funds to complement your mortgage.

Buying Real Estate for Your College Student Requires a Top Real Estate Agent

Owning real estate can be a great way to diversify your income; however, using funds from a 529 plan is not advisable. Account holders will end up paying additional income tax, a 10% federal penalty fee, and potentially state taxes. These added expenses quickly eat up the tax benefits provided by a 529 plan.

If you have decided to buy a house instead of paying rent for your college student, you must start by familiarizing yourself with the real estate market. To ensure you buy in the right area and safeguard your investment, start by connecting with an experienced real estate agent. Your agent will be your local guide, giving you insights on neighborhoods and the best areas to buy for your student’s housing needs.

No matter where you live, you can easily connect with experienced local real estate agents with FastExpert. FastExpert makes it easy to find agents based on experience level and specialization while providing verified reviews and track records.