Use Savings to Minimize Graduate School Loans
Q: I am 30 years old and have roughly $56,000 in various retirement and savings accounts. I expect to enroll in a two-year business graduate program this coming fall which would cost a total of approximately $65,000. With interest rates at their current levels, I am inclined to leave my savings in place and take out a student loan. What do your experts think of this? About $4,000 of my savings is in a bond fund; $15,000 is in a money market fund; $6,000 in is the stock of my employer; $11,000 in in mutual funds, and $20,000 is in a 401(k) account. --A.C.
A: First, let’s examine your situation a little differently. For starters, you shouldn’t consider your 401(k) account to be at your disposal. If you cash it out, you face not only a tax bill but a 10% early withdrawal penalty. So, you really have just $36,000 and will be facing student loans of some sort no matter what you do.
Remember, interest on those loans is not tax deductible, so the operable question should be whether you can make more on your investments that you will have to pay in loan interest. Your money market fund probably can’t pass that test, so our advisers recommend that you cash that account out.
Now, let’s look at those mutual funds. With the market at its current high levels, our advisers recommend that you seriously consider cashing out your account. Their theory is that the market’s potential upside over the next two to five years may be lower than the interest rate you are facing. Of course, this recommendation does not take into account your specific fund, which may be on the verge of a terrific boom. Only you can make the final call. By the way, you should set aside at least three month’s living expenses for an emergency. You are probably better served keeping this account in the mutual fund rather than your money market account because it is likely to generate higher earnings here.
Our advisers recommend cashing out the bond fund and company stock fund entirely to minimize your dependence on student loans.
By the way, once you are back in the work force full time, you should repay your student loans as fast as you can.
Clock Ticks for Taxes Deferred on New House
Q: We have been forced to rent our newly built home because we cannot sell our current residence. If this situation persists for more than two years, can we still consider the newly built home the replacement residence when we finally sell the current home? --C.H.S.
A: The IRS requirements for deferring payment of taxes on a home sale gain clearly specify that the replacement home must be purchased within two years of the sale of the older residence. The replacement home may be purchased within two years prior to that sale or within two years after the sale; the government doesn’t care. If you don’t move into your new home within two years of purchasing it, it will not qualify as your replacement home.
Your case is complicated somewhat by the fact that it apparently was built for you on a lot you had purchased separately prior to construction. In order for all the costs of the land and the structure to qualify as your replacement residence, you must move into the new home and sell your old home within two years of the lot’s purchase. That is when the meter started running on your two-year replacement period.
However, if you miss that deadline, all is not lost; you lose only the ability to include the cost of the land in the total cost of replacement residence. You may still be able to claim the construction cost as your replacement home value if you move into the home and sell your old home within two years of making construction loan payments.
But, be advised: only those payments you have made within those two years count toward the replacement home cost. Depending on when you sell your original home, only a portion of your construction costs may qualify.
Treat Son’s Rental Arrears as a Gift
Q: My son lives in a rental home that I own. Due to the rough economy he is behind on his rent. Must I report the money he owes me as income because he is my son? --L.K.
A: If you do not intend to report a tax-deductible loss on your rental home, your question is moot. The Internal Revenue Service insists that fair market rents be charged to family members and friends to protect itself against “inside” lease agreements that essentially are subsidized by taxpayers at large.
Here are the general rules: If you rent to a family member or friend for less than fair market value, your property loses its rental status in the eyes of the IRS and becomes, instead, a second home. Now, it is subject to the tax rules governing vacation homes which limit deductible expenses to the amount of your income. The bottom line is you can’t report a loss on the home’s rental. So, if the fact that your son hasn’t paid rent for several months puts your rental operation in the red, you can’t claim the loss on your taxes. However, if you don’t have a loss regardless of the rent you’re still owed, then you only have to worry about is the amount of the debt you are forgiving.
You may give any individual $10,000 per year without triggering gift tax consequences. If the amount of forgiven rent is under $10,000, you can consider it a gift. If it’s more, then you must report the excess to the IRS as a taxable gift. Although you may owe no tax on it, the excess will deducted from your $600,000 lifetime, tax-free limit.
