Tax Implications for Reverse Mortgages

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Tax Implications for Reverse Mortgages

In retirement, a reverse mortgage may be useful. After all, you may access your home equity with these loans without having to sell it or add a new monthly payment to your budget. You may be curious about how reverse mortgages effect your taxes given that these loans provide extra income and you pay interest on the revenues.

Here’s a short look at how reverse mortgages affect taxes.

Key Takeaways

  • An vital source of income during retirement, a reverse mortgage may be available to homeowners who are 62 years of age or older and have a significant amount of home equity.
  • When you sell the house, leave the area, or pass away, the reverse mortgage debts become due.
  • Your Social Security or Medicare benefits are often unaffected by any reverse mortgage income you receive.
  • Only if you bought, built, or significantly improved your house with the loan can you write off the interest on your reverse mortgage.

What Is a Reverse Mortgage?

The majority of individuals who purchase a house need a typical mortgage (also known as a forward mortgage) to fund the transaction. You get a loan from a lender, pay it off each month, and increase the value of your house.

If you are over 62 and have a large amount of equity in your home, you may be interested in a reverse mortgage, which gives you access to a line of credit or a one-time lump sum payment from the lender to utilize for things like basic living costs and medical expenditures. However, the debt does not become payable until you sell the house, vacate the property, or pass away, not until you make regular payments to repay it.

It’s typical for reverse mortgage proceeds to be tax-free and to have no impact on your eligibility for Social Security or Medicare benefits.

Tax Implications of a Reverse Mortgage

Reverse mortgages are appealing since they provide extra income that doesn’t need to be paid back for (possibly) a very long time. To avoid unpleasant surprises at tax time, it’s crucial to take the tax consequences into account. Here is a summary of what to anticipate.

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Reverse Mortgage Income

Your reverse mortgage payments are considered loan advances by the Internal Revenue Service (IRS), not income. This implies that the money you get from your lender won’t subject you to any income tax obligations. Comparable in tax treatment to other loan kinds that must be repaid include personal loans, home equity loans, and home equity lines of credit (HELOCs).

Social Security and Medicare Benefits

The money from a reverse mortgage loan won’t typically influence your Social Security or Medicare benefits since it isn’t considered income. However, it can have an impact on your ability to get Supplemental Security Income (SSI), since any monies from a reverse mortgage that you keep (i.e., don’t immediately spend) may be considered assets.

As an example, let’s assume your reverse mortgage lender offers you $4,000, which you use to cover medical expenditures the same month. Your SSI wouldn’t be impacted in that scenario. The money would qualify as an asset if you don’t spend it that month and it remains in your bank account, which might make you ineligible for need-based assistance.

Reverse Mortgage Interest

The house mortgage interest deduction is one of the advantages of home ownership. If you’re married and filing separately, you may deduct $375,000 of the loan’s first $750,000 in mortgage interest. If you took out the loan before December 16, 2017, the limitations are $1 million and $500,000, respectively. The interest is deductible in the year of payment, which lowers your taxable income for the year.

The tax advantages of reverse mortgages are not the same. With a reverse mortgage, however:

  • No interest is charged until the reverse mortgage is fully repaid by you (or your estate), at which point it becomes payable.
  • Any interest paid on a reverse mortgage is considered home equity loan interest, which is often not deductible. In accordance with the Tax Cuts and Jobs Act (TCJA), only home equity loans used to purchase, construct, or significantly renovate a house are eligible for interest deductions. If you utilize the loan funds to pay for anything else, such living costs or medical expenditures, you cannot deduct the interest.
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Capital Gains Taxes

The earnings from the sale of an investment, or the difference between the sales price and your cost basis in the investment, are normally subject to capital gains tax. The IRS permits a specific exception if the asset is your primary residence: If you owned and resided in the property for at least two of the previous five years, you may be able to exclude up to $250,000 ($500,000 if you’re married filing jointly) in capital gains from your tax return.

In situations involving reverse mortgages, capital gains may get complicated. This is why: When the loan is due and you sell the property to pay off the debt, you (or your estate) cannot owe more than the house is worth. In other words, the difference is forgiven if your reverse mortgage debt is more than the selling price of your house. At tax time, however, the sum is considered extra selling profits.

Here’s an illustration: Consider buying a house for $200,000 decades ago and selling it for $450,000 now. You have $250,000 in capital gains, but thanks to the capital gains exclusion, you won’t have to pay taxes on it. But what if you now owe $500,000 on a reverse mortgage on your house? In that situation, $50,000 of the loan would be forgiven—keep in mind that when the loan is due, you can’t owe more than the property is worth.

However, the $250,000 benefit from property appreciation is increased by that $50,000. As a result, a $300,000 gain is now the basis for your capital gains taxes. Even if you lost money on the sale, you must pay capital gains tax on the remaining $50,000. You may still deduct the first $250,000 from tax.

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Do reverse mortgage payments count as income?

Reverse mortgage payments are treated as loan proceeds by the Internal Revenue Service (IRS), not as income. This means that any reverse mortgage payments you get won’t be taxed, and the loan won’t have an impact on your ability to collect Social Security and Medicare benefits.

Can I deduct reverse mortgage interest?

Only if the funds were utilized to purchase, construct, or significantly enhance the house are reverse mortgage interest deductions allowed. As a result, when it comes time to pay off the reverse mortgage, if the loan proceeds were used to renovate the kitchen, the interest might be written off. On the other hand, you cannot deduct the interest if you spent the money to cover essential costs of living or medical expenditures.

Who owns a property in a reverse mortgage?

The Bottom Line

You may prevent any unpleasant tax shocks by being aware of the tax ramifications of reverse mortgages. When in doubt, consult your financial counselor or a tax expert who can provide any more information. Although mortgage insurance fees are often charged by lenders at the same rate, be careful to compare prices: Other loan expenses including origination, service, and interest rates may differ across lenders.

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