Reverse Mortgages and Taxes

A reverse mortgage is basically a financial product that allows usually elderly homeowners the chance of borrowing against their home equity. This product allows a person who is 62 years or older to lend against the equity in the home without making monthly payments; the loan is repaid when the borrower moves out, sells the property, or dies. Even though all these complicated financial benefits come along with them, yet their taxation implication must be known by homeowners for further financial planning.

Tax Implications of Reverse Mortgage

• Not Taxable Income from Loan Proceeds

Another significant aspect of reverse mortgages is that the payout from the loan is not classified as taxable income. Any payments made by a reverse mortgage for example are treated as loan advances; hence, any money a reverse mortgagor receives from a reverse mortgage will not be subject to the income tax laws within the United States. Therefore, they should not include any loan amount in their tax returns.

• No Effect on Social Security or Medicare Benefits

Because reverse mortgage proceeds are considered loans, they do not affect a borrower’s qualification for Social Security benefits or Medicare. Any amount received through a reverse mortgage is considered an asset and not income; thus, it does not affect the amount a person qualifies to receive as Social Security benefits. Funds, however, if spent on non-health sources can affect one’s Medicaid eligibility; hence a financial advisor should be consulted for specific advice.

• Interest Will Accrue and Will Not Be Deductible Until Paid

Interest will accumulate on a reverse mortgage during the life of the loan and it generally does not have to be paid until the loan is paid off. Interest is deductible under taxation principles but only after it has been paid. This means that the interest will not be deductible from taxes as long as it is still accumulating. Only after the repayment of the loan interest can their deduction occur- that is, usually when the borrower sells the home, moves, or dies.

• Home and Capital Gains Tax

Upon repayment of the reverse mortgage loan through the sale of the home or in any other way, the proceeds that come from the said sale may be subjected to capital gains tax based on the sale price against the basis for your home. The basis of a home is usually its original purchase price plus additional capital improvements made to the house while owned. If the gross proceeds from the sale exceed the basis of the home, the excess will usually be subject to tax as capital gain. However, if the taxpayer has met the primary residence exclusion ($250,000 maximum gain for single filers, $500,000 for married couples), he may not have to pay taxes on any gain.

• Impact on Estate Tax

If the reverse mortgage borrower dies, the remaining loan should then be paid from the proceeds coming from the sale of the house, which would likely lower the estate’s eventual value and thus affect estate tax liabilities if the total value of the estate is more than the federal estate tax exemption limit. If the home is not sold, the lender may initiate a foreclosure process to recover the loan amount.

• Property Taxes and Insurance

Reverse mortgage proceeds are non-taxable, but the borrower still has the obligation to pay property taxes and homeowners insurance in a reverse mortgage. If these are not kept up to date, the lender can, in fact, initiate foreclosure proceedings in order to recover the loan balance.

• Taxable Implications for Heirs

If heirs are inheriting a home with a reverse mortgage, tax implications will depend upon whether the home is sold or kept. If the home is sold, profit from the sale could be capital gains income, although a decreased amount of gain may be taxable because of the property receiving a stepped-up basis upon inheritance. If it is held and repaid over time, the heirs will continue paying property taxes and homeowners insurance.

Major Considerations

• Consult a Tax Professional: A reverse mortgage will complicate taxation, especially on the deduction aspect, estate planning, and long-term financial planning. Reverse mortgage planning homeowners should speak with a tax professional to gain a full understanding of the potential tax ramifications based on their unique circumstances.
• Documenting Costs: Homeowners should keep accurate records of any fees, interest, or payment in reference to a reverse mortgage. These records can be beneficial upon home sale, mortgage payoff, and tax filing.
• Change in Tax Laws: Since the IRS’s tax rules may amend or change, being aware of any changes in reverse mortgage taxation will be necessary, especially as it relates to estate tax adjustments or exemptions on price when selling a home.