All Law Blog

529 Saving Plans.

Ingrid D.B.B. Berger
Global Law, LLP
Ingrid@globallawllp.com
© 2008 Ingrid Berger.  All rights reserved.

Faced with ever-higher tuition costs, parents can use all the help they can get.  “529” plans allow parents to set aside enough funds to pay for tuition in a tax advantageous way.  Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study, and for room and board under certain circumstances at any accredited college, university or vocational school in the United States and at some foreign universities.   Keep in mind that contributions to a 529 plan may only be made in cash (i.e., check, money order, credit card and similar methods).  You may choose between two options: the (1) Prepaid tuition plans under which you purchase tuition credits that enable the beneficiary to matriculate at a state-sponsored institution without fear that tuition costs will rise so much as to jeopardize the beneficiary’s ability to attend college. A prepaid plan often does not, however, cover the costs for room and board; or the (2) Savings plans under which funds are deposited into an investment account managed by a professional investment advisor.

Income Tax Considerations. While your contribution is not deductible from your federal income tax, your investment will grow tax-deferred and withdrawals will not be subject to federal income tax to the extent that the distributions are used for qualified higher education expenses.  Note that some states provide state income tax deductions for all or part of the contributions.  You should check with your tax advisor to see whether your state offers income tax deduction for contributions to a 529 plan.  Moreover, since 2001, distributions including cash, earnings (dividends, interest, and gains on sales) are excluded from the designated beneficiary’s gross income to the extent that the distribution is used to pay for qualified higher education expenses.  Be aware that a 10% penalty will apply to any distribution which is not used to pay for qualified higher education expenses for a reason other than the death or disability of the beneficiary, or to the extent that the distribution exceeds amounts not covered by scholarships.  States may also impose a penalty for distribution not used properly.  For instance, also some states will impose a penalty for distribution made for expenses other than for qualified higher education expenses (California imposes a 2.5% penalty).

Gift tax Treatment.  529 contributions are treated as gifts subject to gift-tax limitations, if you want to make a tax-free contribution, it shouldn’t exceed $12,000 annually ($24,000 if you’re contributing with your spouse). There’s one exception, however: you may contribute as much as $60,000 tax-free in one year ($120,000 with your spouse), but that contribution will be treated as if it were being made in $12,000 installments over the next five years. That means you can’t make other tax-free gifts to the beneficiary during that time.

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Vacation Home Exchanges

New Guidance from the IRS

By

Michael S. Powlen
Global Law, LLP
© 2008 Michael Powlen.  All rights reserved.

            An important part of real estate investment is the ability to exchange out and into properties on a tax-deferred basis under Internal Revenue Code Section 1031.  Many investors trade up into new properties, change property types, change markets multiple times over many years without ever paying tax on the appreciation.  The companion provision to 1031 is Code Section 121, which allows homeowners to exclude gain up to $500,000 on the sale of a principal residence. 

            Second homes or vacation homes may fall into the gap between these two provisions, as second homes are not principal residences (so won’t qualify under Section 121) and may not qualify as investment property.  A requirement of Section 1031 is that property be held for investment or for productive use in a trade or business.  Courts have held that property that exclusively availed of for personal use does not qualify under Section 1031. 

            The IRS has recently issued Revenue Procedure 2008-16, which sets out safe harbor guidelines for like kind exchanges of vacation homes.  If a taxpayer follows these guidelines, then the IRS won’t challenge the exchange.  This Revenue Procedure provides that a dwelling unit qualifies under Section 1031 as property held for investment or held for productive use in a trade or business if:

(1) For the relinquished property:

(a) the dwelling is owned by the taxpayer for at least 24 months immediately before the exchange (the “qualifying use period”); and

(b) Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange:

(i) The taxpayer rents the property at fair rent for at least 14 days or more, and

(ii) The taxpayer does not personally use the dwelling unit more than the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit was rented at a fair rental rate.

(2) For the replacement property:

(a) The dwelling unit is owned by the taxpayer for 24 months or more immediately after the exchange (the “qualifying use period”); and

(b) Within the qualifying use period, in each of the two 12-month periods immediately after the exchange:

(i) The taxpayer rents it at fair rent for at least 14 days or more, and

(ii) The taxpayer does not personally use the property for more than the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit was rented. 

These rules are similar to the rules under Code Section 280A that govern when a taxpayer can take deductions on residences that are used as vacation or second homes. 

Bear in mind that the safe harbors in the Revenue Procedure are guidelines for when the IRS won’t challenge a transaction and not substantive statements of law.  A like kind exchange could still qualify even if it violated the safe harbor.  For example, if a taxpayer owned a vacation rental property for 18 months, rented it out at market rents for ten months a year and used it personally for one week a year, the property should clearly qualify for like kind exchange treatment even though the 24 month holding period in the Revenue Procedure is not met. 

While the Revenue Procedure leaves many grey areas, it does provide a safe harbor that may give many real estate investors peace of mind. 

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