Covering Children Tuition Costs with Capital Gains

Many parents may find themselves in a position where they must sell investments to pay for a child’s college tuition. These investments could have appreciated over the years, generating capital gains tax in the year that the investments are sold. However, if these funds are shifted to a child attending college, there is a tax strategy that can significantly lower or possibly eliminate any tax due.

The Strategy:

Prior to the child attending college, parents would gift appreciated investments to the child to hold allowing the investments to further grow. Once the child starts attending college, he or she would then sell the investments and use the money to pay for tuition themselves. This would allow the child to pay for tuition and open doors on their personal income tax return. First, the child is now providing over 50% of their own support allowing them to claim themselves as a dependent. By doing this, it allows them to claim a personal exemption on their own tax return reducing taxable income (capital gain income from investments). Second, the child benefits from the full standard deduction further reducing taxable income. If a child were claimed as a dependent on their parents return, the standard deduction has the possibility of being limited. By a child being able to claim themselves, it ensures the full standard deduction is allowed. Lastly and most beneficial, the child is allowed to claim the American Opportunity Tax Credit allowing up to $2,500 of income tax to be removed. Looking at the possibilities, a child could generate up to $28,000 in long-term capital gain income with the possibility of wiping out any income tax due.

Using this strategy allows the parents to sell appreciated investments with no tax liability which may have needed to be sold anyway to pay for their child’s tuition.

Please call your Hertzbach Tax Advisor with any questions or concerns at 800-899-3633. We look forward to speaking with you.