If you are considering selling financial assets, such as stocks, bonds, or mutual funds, to pay for a college education, then you may be wondering how capital gains from those assets impact your eligibility to receive financial aid. Unless the assets are held in a 529 college savings plan or other qualified education savings plan, capital gains from financial asset sales do affect families’ eligibility for need-based financial aid. However, when it comes to selling financial assets to pay for school, ownership and timing are everything.
Who Owns the Assets?
When financial assets are sold, any capital gains received are treated as income. The IRS almost always requires that capital gains income be reported as part of adjusted gross income, which in turn is reported on parents’ and students’ financial aid applications. The U.S. Department of Education, which utilizes the Free Application for Federal Student Aid (FAFSA), and the College Board, which utilizes the College Scholarship Service (CSS) Profile, each employ different methodologies to determine students’ eligibility to receive need-based financial aid. However, both the Department of Education and the College Board apply heavier weights to student income than parent income (above certain income protection allowances). As such, capital gains income received by students more significantly reduces eligibility for financial aid than capital gains income received by parents.
When Will the Assets be Sold?
Capital gains must be reported as income for the tax year during which the financial assets are sold. Selling off a substantial portion of assets can have the effect of artificially inflating a taxpayer’s income for the tax year in which the assets are sold, so it is important to carefully consider the timing of asset sales. The FAFSA and CSS Profile both utilize income data, taken from tax returns, for the year that is two years prior to the school year for which financial aid is being requested. (For example, if you are applying for financial aid for the 2019-20 school year, then you must provide your 2017 tax information.) As such, to the extent possible or desirable based on market conditions, it is best to realize income from capital gains at least two tax years prior to first submitting a FAFSA or CSS Profile. This typically means selling financial assets, and realizing the capital gains, no later than the fall of the student’s sophomore year in high school.
If assets need to be sold within the timeframe that is relevant for obtaining financial aid, then another strategy for minimizing or eliminating the effect of capital gains income on financial aid eligibility is this: balance capital gains with capital losses. Realizing capital losses on investments, while not exactly desirable, offsets capital gains on a 1:1 basis for tax (and financial aid) purposes. So, if you are unhappy with the performance (past or predicted) of any of your investments, then you can - and should - consider selling those underperforming holdings to reduce or eliminate the effect of capital gains income on your eligibility to receive financial aid.
What Happens if I Choose to Just Hold My Assets?If you choose to simply hold your financial assets rather than selling them, then those assets will still impact your eligibility to receive financial aid. Learn more about how assets are treated on the FAFSA and on the CSS Profile, from the experts at Edmit.