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You might be curious about the tax repercussions of a reverse mortgage and whether the money you receive is taxable if you’re thinking about getting one. Reverse mortgages enable senior homeowners to turn the equity in their homes into cash during their retirement years, which they can use to supplement their income, pay for home maintenance and repairs, or meet other costs.
One factor that makes them appealing is that they provide additional cash flow similar to a home equity loan but don’t require repayment until the borrower passes away, sells the house, or vacates. However, that is also the reason why they are a challenging financial product to handle during tax season.
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Note from the Editor: This article’s content is solely based on the author’s opinions and suggestions. It might not have received approval from any of our network partners through reviews, commissions, or other means.
You might be curious about the tax repercussions of a reverse mortgage and whether the money you receive is taxable if you’re thinking about getting one. Reverse mortgages enable senior homeowners to turn the equity in their homes into cash during their retirement years, which they can use to supplement their income, pay for home maintenance and repairs, or meet other costs.
One factor that makes them appealing is that they provide additional cash flow similar to a home equity loan but don’t require repayment until the borrower passes away, sells the house, or vacates. However, that is also the reason why they are a challenging financial product to handle during tax season.
5 tax implications of a reverse mortgage
The good news is that a reverse mortgage’s proceeds are not regarded as taxable income. But that doesn’t mean that you, the borrower, or your heirs won’t face any tax consequences. We’ll go over the advantages and disadvantages of a reverse mortgage below to assist you in making future plans.
Reverse mortgage income
Your reverse mortgage proceeds are not taxable income. The money is viewed by the IRS as loan proceeds rather than income. Similar to other funds that must be repaid, such as a standard home equity loan or line of credit or a personal loan, this tax treatment is also subject to repayment.
Social Security and Medicare eligibility
Reverse mortgage loan proceeds won’t affect your Social Security retirement or Medicare benefits because they aren’t regarded as income. However, they may have an impact on need-based benefits like Medicaid or Supplemental Security Income (SSI).
This isn’t an issue if you intend to use the reverse mortgage proceeds right away, according to the National Reverse Mortgage Lenders Association (NRMLA), which says, “funds that you retain count as an asset and could impact eligibility.”
Your SSI won’t be impacted, for instance, if you borrow $5,000 from a reverse mortgage for home repairs and use it within the same month. However, if you keep the cash in your bank account, it counts as an asset and may disqualify you from receiving need-based assistance.
One of the most significant tax ramifications of reverse mortgages is capital gains taxes. When you sell a capital asset, such as real estate, stocks, or other investments, you must pay capital gains taxes. When you sell an investment, you typically have to pay taxes on the difference between the sales price and your basis—typically, the price you paid when you bought it. When you sell your primary residence, the IRS does permit a special exclusion. You can exclude if you’ve owned and lived in the house as your primary residence for at least two of the previous five years.
If your mortgage balance is higher than the home’s sale price, complications may arise, which is one of the drawbacks of reverse mortgages. The difference between the loan balance and the sale price in this instance is waived. When you sell your house, the amount that was forgiven counts as additional proceeds.
An example:
Imagine purchasing your home in 1989 for $400,000 and selling it today for $650,000. You would have $250,000 in capital gains, but thanks to the exclusion for capital gains from home sales, none of them would be subject to tax.
However, suppose you obtained a reverse mortgage on the same property and are currently responsible for $700,000. $50,000 of the reverse mortgage would be waived if you sold your house. You have $300,000 in capital gains, which includes $50,000 in “gains” from loan forgiveness in addition to the $250,000 gain from home appreciation. Only $250,000 of that would be exempt, so even though you leave the sale with nothing in your pocket, you’ll still be responsible for paying capital gains taxes on the remaining $50,000.
Mortgage interest payments
For some individuals, one advantage of homeownership is the tax deduction you receive for interest paid on a conventional mortgage. However, a reverse mortgage is not always the case because you do not make monthly mortgage payments and the principal of your loan increases each month as reverse mortgage costs are added on. As a result, you can’t deduct the interest on a reverse mortgage until you actually pay it, which is typically when you repay the loan in full.
Even then, it might be difficult to use the deduction’s tax benefits. That’s because the regulations for deducting interest on a home equity loan were altered by the Tax Cuts and Jobs Act (TCJA) of 2017. Currently, you can only deduct interest from debt used to purchase, construct, or significantly improve a home. Therefore, if you get a reverse mortgage to renovate your kitchen, you might be able to write off the interest when you sell your house and settle the reverse mortgage. It is not deductible if you use the proceeds from the reverse mortgage to pay for other living expenses.
An example:
A couple takes out a reverse mortgage to buy a new, smaller house for their retirement, and they don’t use the money for anything else. The reverse mortgage has accumulated interest of $250 000 after 20 years. They completely pay off the reverse mortgage by selling the house and moving into an assisted living facility. At that point, all $250,000 of interest is deductible.
Additionally, bear in mind that the IRS only permits mortgage interest deductions for up to $750,000 of mortgage debt. Your interest deduction will be restricted if the reverse mortgage’s principal balance exceeds $750,000.
Even with a reverse mortgage, you are still liable for paying property taxes. In fact, timely payment of your real estate taxes and homeowners insurance is one of the reverse mortgage requirements. Your reverse mortgage lender may:
You might be able to write off your property taxes on your tax return, whether you handle them yourself or the lender does. However, it is once more difficult to determine whether the deduction will be advantageous to you.
First, you must itemize deductions on Schedule A, which requires that the sum of your itemized deductions—including those for charitable contributions, state and local taxes, mortgage interest, and medical expenses—exceeds the available standard deduction. Only about 11% of taxpayers itemize deductions now that the standard deduction has increased for all filing statuses as a result of the TCJA.
The TCJA also sets a $10,000 ($5,000 if married filing separately) limit on the amount of state and local taxes you can deduct. If your state doesn’t impose an income tax, this also applies to sales taxes, state and local income taxes, and property taxes.
FAQs: Understanding reverse mortgages
Reverse mortgage proceeds are not considered taxable income. The funds are viewed as loan proceeds rather than income under the reverse mortgage rules of the IRS.
What happens if I want to sell my home, but it’s not worth as much as the reverse mortgage?
If the home’s value is higher than the mortgage balance, selling a house with a reverse mortgage is straightforward. Sell the property, settle the reverse mortgage, and keep the profit. However, the lender will accept 95% of the home’s appraised value or the entire loan balance, whichever is less, if the value of your house has decreased below the amount you owe.
If you have to sell your home and it is worth less than what you owe, you might need to conduct a short sale, where you sell it for less money. The issue is that any real estate agent you hire must obtain the lender’s consent to list the house for less than the mortgage balance, and the lender might demand an appraisal before approving the listing. One of the disadvantages of a reverse mortgage is that it can be difficult and time-consuming to short sell a home.
Is interest on a reverse mortgage tax deductible?
On a reverse mortgage, you can only deduct interest once it has been paid. You might never be able to take advantage of the tax deduction because most reverse mortgages aren’t paid until the house is sold or the borrower passes away.
The interest must also adhere to the additional requirements for home mortgage interest deductions. Home equity debt is only deductible under current tax law if the loan proceeds were used to purchase, construct, or significantly improve the home. The interest is not deductible if you used the loan proceeds for any other purpose, such as covering living expenses.
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FAQ
What happens to the interest on a reverse mortgage?
Each month, interest is added to the balance you owe as a result of the money you receive from your reverse mortgage. That implies that as your loan’s interest accrues over time, your balance increases. Interest rates may change over time.
What mortgage interest is not deductible?
If the loan proceeds were used for business, investment, or other tax-deductible purposes, the interest you pay on a mortgage for a home other than your primary residence or second home may be deductible. Otherwise, it is considered personal interest and isn’t deductible. Main home. There can only ever be one primary residence for you.
Who pays the interest on a reverse mortgage?
Only the amounts actually borrowed from the credit line are subject to interest payments by the homeowner. Equal monthly payments plus a credit line are made by the lender so long as at least one borrower uses the property as their primary residence.
Is mortgage interest still tax deductible 2022?
The 2022 tax season is approaching, so it’s critical to make sure you can maximize your savings. The mortgage interest deduction essentially enables homeowners to lower their taxable income by the amount of home interest they paid for the tax year. This requires itemizing on tax returns.