September 14, 2000

Dorm option: Do you really want to play landlord?

As we planted our oldest offspring on the plane to his second year of college instruction from the good Jesuit fathers, I began to compare his options with the ones I considered 30 short years ago.

Charley could take a semester off and work at an oceanfront marina and help offset his collegiate expenses. Had I done so in 1970, I would have lost my student deferment from the military and been given an express ticket to an oceanfront in Southeast Asia.

Charley has no obligation to live on campus, a stark contrast to a freshmen-sophomore requirement when my group was enrolled.

If you are ready to drop your son or daughter in a college environment, payment shock is probably alive and well in your household.

And, you have probably asked yourself more than once if this is a good time to consider buying a home near campus as an alternative to dormitory living.

But before you start visiting homes for sale near a college or university in the next few weeks, take a look down the road. How many years to you expect your child to live there and, if he transferred or "stopped out" for a term, would you want to rent to students you have never met?

Many accountants advise parents with college kids to estimate what home prices will be when the child's course work is done. Will that market appreciate 5-7 percent a year, or perhaps 30 percent in five years?

If your child is headed to an established college or university, the chances are very good your investment will show at least modest appreciation. Even historically slow housing areas are experiencing a comeback and homes in college towns typically have appreciated at a greater pace than the national average.

But just how much appreciation is necessary to make the numbers work? I've been given a rule of thumb that if the house appreciates as much as the parent's annual tax bracket, the deal may definitely be worth doing.

For example, if you are being taxed at 28 percent and feel the investment will appreciate 28 percent in the time you hold it, it could be a nice option for everybody involved.

Typically, the student manages the building while mom and dad reap the tax benefits and appreciation that come from owning a rental home.

Often the venture won't work because some buildings near schools are too expensive for the numbers to properly crunch. Also, there is the initial problem of handling the down payment and monthly expenses -- in addition to skyrocketing tuition fees.

Let's say you found a home in Tacoma near the University of Puget Sound that costs $127,000. You would make a down payment of at least $12,700. If you finance the remaining $114,300 at an interest rate of 7.5 percent over 30 years, your principal interest payment will be about $800 a month. Toss in taxes, fire insurance, and a few light bulbs you will be looking at $1,000 a month.

That's not too bad, if you can get four mature kids to pay $250 a month rent, not including food and other essentials. Students could probably eat and live in a dorm for less, (young women rarely eat dormitory food anyway) but this way they have an alternative to noisy halls, and the parents have a fairly secure, four- to six-year venture.

A big decision is how to treat the college home as far as Uncle Sam is concerned. It could either be a second home or an investment property.

If it's definitely going to be a rental, you can't rent to your children and their friends for a song. The IRS will not allow you to show a taxable loss on the property if you personally use it for more than 14 days or 10 percent of the total rental period. "Personal use"' includes renting to any relative unless you charge a "fair market rent."

If the student-partner does not pay rent, depreciation cannot result in a taxable loss. Expenses may be deducted, but not to the point where an actual loss is shown.

In order for the parent-student partnership to work, students must be responsible landlords. That's why I still can't answer if I would have rented to my group of four just 30 short years ago.

Previous columns:

• Location, location, schools, 09-07-2000
• Beware the predatory lenders, 08-31-2000
• Fix-up, remodel or move, 08-24-2000
• Limiting renters in condos, 08-17-2000
• New mantra: location, location and wired, 08-10-2000
• Tips on buying property in Canada, 08-03-2000
• Manufactured homes are improved and so is financing, 07-27-2000
• New wrinkle in reverse mortgages, 07-20-2000