Tom Kelly: What to do if your child-manager leaves college early

Friends of mine are coming to terms with their child’s decision to drop out of school and spend “at least a semester” in the film industry. They wanted their son to finish his degree as soon as possible and save the cost of another term.

An associated concern is the management of the small house they own and rent to their son and other students that is close to campus. If their son is gone, will there be mature individual who can collect rent from the three other roommates and keep the place from becoming a miniature Animal House? The topic has become a significant issue in some college towns as absentee owners rent to undergrads, upsetting once quiet neighborhoods.

Unlike in the past, many college students today have no obligation to live on campus. In fact, college dormitories are so jammed at many schools that individuals are encouraged to seek off-campus housing. That could be an appealing investment opportunity for you, yet proceed with caution.

But before you get serious about a purchase near a college or university, take a look down the road. How many years do you expect your child to live there and, if he transferred or “stopped out” for a term, would you want to rent to his friends or 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? There is 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 25 percent and feel the investment will appreciate 25 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 depreciation 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 fixer home in a college town (Bellingham, Pullman, Ellensburg, Spokane, Walla Walla, Cheney, Parkland, Tacoma … maybe even a condo in Seattle?) that costs $200,000. You would probably make a down payment of at least $20,000, perhaps coming from the equity in your primary residence. If you finance the remaining $180,000 at an interest rate of 4.5 percent over 30 years, your principal and interest payment will be about $912 a month. Toss in taxes, fire insurance, and a few new keys and you will be looking at $1,200 a month.

That’s not too bad, if you can get four mature kids to pay $350 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. So, if your student is not, perhaps you can choose one of his or her friends who is more organized and maintenance oriented.

And, have Plan B in place if your house manager takes a semester off.