How to Put Your Kids Through College Tax Free with Real Estate: a Guide for Parents
We skipped the 529 plan and bought an 8-unit apartment for our three young kids. Here's a 15-month update and comparison of real estate vs 529 plans
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How to Put Your Kids Through College Tax-Free with Real Estate
A little over a year ago my wife and I bought an 8-unit rental property to put our kids through college tax-free.
We have three kids under 10 years old.
They’re fortunate to have cash from birthdays, gifts from grandparents, and enough money saved to put to work for college.
We had 3 options:
Leave in savings earning 1%
Open a 529 college plan
Buy real estate
We chose real estate.
The problem was…
We found an amazing (unaffordable) 8-plex in North Dakota.
The Purchase Story & Breakdown
The property was listed for $450,000, more than double the $240,000 purchase price we budgeted for.
But this is when you get creative and find more leverage.
We increased the buyer’s commission to $50K.
My wife is a licensed broker. Increasing the buyer’s commission (that gets paid back to us) increased the purchase price and amount the bank would lend us. Adding the buyer’s commission increased our leverage to buy the property.
Here’s how we made the purchase work
New Purchase Price: $500K
Buyer Commission: $50K
Down Payment: $75K
Loan Amount: $375K
I chipped in $15K that my kids will pay back with cash flow in year 1.
Then it's 100% their property.
Financials on the property
Annual Rents = $75K
(Annual Expenses) = $40K
(Annual Mortgage) = $22.5K
✅ Net Cash Flow = $12,500
Plus appreciation over 10 years
*Plus a cash-out refinance in 10 years
*The refinance in 10 years is key for tapping into to equity to buy even more rental properties in the future.
This is a great alternative option to 529 college plans.
Let’s look at some of the biggest Pros and Cons.
The Pros and Cons: 529 College Plans vs Rentals
1. Cash Flow
Rental Property:
Immediate Cash Flow: Once the property is rented out, you’re making monthly cash flow to pay the mortgage and net some free cash flow
Reinvest or Save: The positive cash flow can be reinvested in other ventures or saved for future use
529 Plan:
No Immediate Cash Flow: Money invested in a 529 plan doesn't yield immediate accessible cash flow as a rental property does. Instead, the money compounds over time to be used for educational expenses.
No Reinvestment Opportunities: You can't harness the benefits of compound interest in the same way you can with reinvesting immediate rental income.
2. Tax Benefits
Rental Property:
Depreciation: One of the most significant tax benefits for real estate investors is depreciation. This allows you to offset a portion of your rental income, reducing taxable income.
Deductible Expenses: Mortgage interest, property taxes, maintenance expenses, insurance, and even travel costs related to property management can be deductible.
1031 Exchange: down the line our kids can decide to sell this property and reinvest in another one without paying capital gains taxes using the 1031 Exchange strategy.
529 Plan:
Tax-Free Growth: One of the primary advantages of a 529 plan is that earnings grow tax-free.
Tax-Free Withdrawals: As long as the withdrawals are used for qualified educational expenses, they're not taxed.
3. Long-Term Appreciation:
Rental Property:
Potential Appreciation: Over time, real estate, in general, tends to appreciate. Although market fluctuations can impact short-term values, long-term holds often see notable appreciation.
Value-Add Opportunities: Investors can actively boost a property's value through renovations and upgrades.
529 Plan:
Dependent on Market Performance: The appreciation of a 529 plan is tied to the performance of its underlying investments, such as stocks or bonds. While these can appreciate over time, they are also subject to market volatility.
No Active Appreciation Opportunities: Unlike rental properties, you can't increase the value of your 529 plan through active interventions.
4. Overall Wealth Generation
Rental Property:
Leverage: Real estate allows investors to leverage their capital, buying a property worth multiple times their initial investment. This can amplify wealth generation, especially with property appreciation.
Diversification: Each property added to a portfolio offers diversification, reducing the risk tied to any single property.
Legacy and Tangibility: Real estate is a tangible asset that can be passed down through generations, potentially providing wealth and income for an investor's descendants.
529 Plan:
Diversification through Investment Options: Depending on the 529 plan, investors can diversify across stocks, bonds, and other assets.
Purpose-Specific: The primary goal of a 529 plan is to fund educational expenses. While it's a noble and necessary cause, it doesn't have the multifaceted wealth generation potential that real estate offers.
Limited Legacy Options: While some portion of the 529 plan can be passed down, its purpose remains education-centric.
15-Month Update
It’s been 15 months since we purchased the 8-plex. We’ve put in a lot of sweat equity and taught the kids how to operate their first property.
Here are 10 BIG Updates On How It's Going
1. Painted the exterior
2. Added new signage
3. Cleaned up the property
4. From 75% to 100% occupied
5. 6-months capital reserves built up
6. Cash flowing $2,000 per month
7. Kids owe dad $15,000 completed by the end of 2023
8. We're converting a 400 SF common area into a 9th unit for more cash flow
9. Garden-level properties are the easiest to manage so far
10. Future cash flow will pay for all 3 kids’ future liabilities: Phones, cars, insurance, licensing, college, rent, startup money for business
I’m not doing this to reduce my bills but to show my kids how to get to financial freedom at a young age. My hope is they buy more properties in the future that build the legacy for their families.
This is one of the best financial decisions we've made for our kid’s future!
Before we made property improvements
After property improvements: paint, new sign, cleaning up a bit
Which is better?
While both rental properties and 529 plans offer unique advantages, their wealth generation potentials are rooted in different principles.
Rental properties provide more active control, immediate cash flow, and multifaceted wealth generation
529 plan is a more hands-off, purpose-specific investment
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Awesome guide more parents need to see this Marc!