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Dear Tax Talk,
If I sell my rental property, and immediately put the sales proceeds to my kids’ college fund (non-taxable), will I still have to pay the capital gain tax?
— Mary J.
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Dear Mary J.,
Sorry! Directing the sales proceeds to your kids’ college fund does not eliminate the capital gains tax on rental property. However, all is not lost because if you qualify, there are many tax benefits in the form of credits and deductions that may be available to you once you start paying those college expenses. Additionally, there are potential tax savings if you open certain types of education savings accounts that will be used in the future.
The first item on your agenda should be to sit down and calculate the taxes that will be owed on the sale of the rental property, keeping in mind that not all of the gain may be taxed at capital gain rates due to the depreciation recapture rules. Additional taxes may be owed due to the net investment income tax.
What is net investment income tax?
Higher income investors now pay additional taxes toward Medicare. The tax is 3.8% of net investment income, which includes:
- Capital gains
- Income from passive business activities
The tax applies to single and head of household taxpayers who earn $200,000 or more, and to married filing jointly taxpayers with adjusted gross incomes of $250,000 or more.
The next item on your list should be to take a good look at IRS Publication 970, Tax Benefits for Education, so you can maximize the tax benefits of those future college expenses. There is an array of options available to you starting with setting up college funds that grow tax free if used for qualified education expenses, such as a 529 Plan, a Coverdell education savings account or a state prepaid college program.
Additionally, 2 tax credits are available if you are paying for higher education expenses.
- The first is the American opportunity credit which is for students in the first 4 years of college and can be worth as much as $2,500 per eligible student for 2016.
- There is also a lifetime learning credit which can be worth as much as $2,000. You claim the credits on Form 8863 and attach it to your Form 1040.
Credits are wonderful, but if you don’t meet the requirements you can look into claiming the tuition and fees deduction. And if it turns out you need to take out some student loans, the interest may be deductible.
As for the sale of your rental property, you may want to consider seeking qualified professional assistance.
Need help with your personal finances? Find a financial planner near you.
Thanks for the great question and all the best to you and your family.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.