The best way to save for college

June 1, 2003
My broker has been pushing me to start a Section 529 College Savings Plan for each of my children. Is it truly the best way to save for college?

Charles Blair, DDS & John McGill, MBA, CPA, JD

My broker has been pushing me to start a Section 529 College Savings Plan for each of my children. While I understand that there may be some tax benefits associated with this, is it truly the best way to save for college?

Our research and analysis has proven that the most cost-effective way to meet the doctor's share of educational costs for his children is through methods which are tax-deductible to the practice, allow earnings to grow on a tax-deferred basis, and which will be paid out tax-free for educational expenses.

In that regard, contributions to Coverdell Educational Savings Accounts and Section 529 plans are not deductible for federal income- tax purposes, although some states do provide full or limited state-income tax deductions. Thus, the primary means of funding college educational costs should be through tax-deductible methods.

Once the college educational funding amounts have been provided through tax-deductible means, Coverdell Educational Savings Accounts and Section 529 plans are ideal to allow the funds to grow and accumulate on a tax-deferred basis, and be paid out tax-free for educational purposes. However, the lower returns generated in this investment climate and the higher investment fees involved with some Section 529 plans may mean that the actual savings to the doctor may not be nearly as great as represented by many brokers. For specific information on funding college educational costs with tax-deductible dollars, send a stamped ($.60) envelope to Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, and request "How to Slash College Educational Costs."

Recently I attended a tax-planning seminar where the speaker said that doctors could receive up to $500,000 of gain tax-free, not only from the sale of their personal residence, but also from the sale of their office building. Is this correct?

Under Section 121 of the tax law, married doctors can exclude up to $500,000 of gain from the sale of their personal residence, provided they have lived there for at least two years. There is no provision in the tax law that allows the exclusion of up to $500,000 of gain from the sale of your office building.

However, Blake Hassan, a CPA and tax attorney specializing in practice-transition tax matters with McGill and Hassan, P.A. (704-424-5450) has developed a way to accomplish this result indirectly. Hassan says that the first step in this transaction is for the doctor to swap his existing office building in exchange for residential rental real estate (e.g., a condo in Florida in a tax-free exchange sanctioned under Section 1031 of the Internal Revenue Code.) The doctor then rents out this property to tenants for a one-to-two-year period to solidify its status as rental real estate, thus qualifying the original exchange for tax-free status.

My wife and I have lived in separate states for many years — I am a resident of California and she lives in Utah. However, we continue to file a joint, federal income tax return and individual returns to the states of California and Utah. Recently, I sold a rental property in California that was jointly owned. Will capital gains taxes have to be paid in Utah, as well as in California?

Since the real estate is located within the state of California, the entire gain from the sale of the rental property will be subject to state income taxes there. Your wife would have to file a nonresident return in order to report her share of the capital gain there. Since your wife is a resident of the state of Utah, she would be required to report the gain on her Utah return, but would receive a state income-tax credit for the capital gain taxes paid to the state of California. In this manner, the gain would effectively be subject to state income taxation only once, rather than twice.

Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($195 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, or call (704) 424-9780.

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