For clients with a business, IRC Regulation 1.163-10T(o)(5) allows personal residence interest to be treated as a business expense, if the loan was used for business purposes. In addition to a tax deduction, that is not subject to the itemized deduction phase-out at high-income levels, this deduction reduces the social security and Medicare tax liability for a self-employed client, if the interest expense qualifies as business interest expense. Subsequently, the deduction will lower income reported for financial aid purposes.

Specific Details

A parent wishes to borrow money for his child’s college costs. To achieve the maximum financial aid and tax benefits, the parent takes a mortgage on his personal residence. The loan proceeds are used in the parent’s sole-proprietor business. The parent pays for college expenses from the cash flow generated from the business. The result is that the interest is a business interest expense that lowers the parent’s Adjusted Gross Income. The lower Adjusted Gross Income decreases the client’s EFC. In addition, the net worth of the personal residence is lowered. If the parent’s child attends a college that assesses the personal residence, the lower value will also decrease the EFC.

Potential Savings

If you are in a financial aid income assessment rate of 47%, you could increase your financial aid eligibility up to $470 for every $1,000 of income reduction by deducting personal residence interest as a business expense.