Tax Implications for Reverse Mortgages

Good news: The loan proceeds don’t count as income

A reverse mortgage can be a helpful retirement tool. After all, these loans let you tap into your home equity without selling the house or taking on an extra monthly payment. Because these loans provide supplemental income—and you pay interest on the proceeds—you might wonder how reverse mortgages affect your taxes.

Here’s a quick look at the tax implications of reverse mortgages. 

Key Takeaways

  • Homeowners age 62 or older with substantial home equity may qualify for a reverse mortgage, which can provide an important source of income during retirement.
  • Reverse mortgage loans become due when you sell the home, move away, or die.
  • Any income that you receive from a reverse mortgage does not generally affect your Social Security or Medicare benefits.
  • You can deduct reverse mortgage interest only if you used the loan to buy, build, or substantially improve your home.

What Is a Reverse Mortgage?

Most people who buy a home need a traditional mortgage (sometimes called a forward mortgage) to finance the purchase. You borrow money from a lender and pay down the loan each month while building equity in the home. 

Once you reach age 62 and have substantial equity in the home, you may be interested in a reverse mortgage, which generates from the lender a one-time lump sum, a set amount each month, or a line of credit that you can use for basic living expenses, medical bills, and the like. However, instead of you making monthly payments to pay it back, the loan doesn’t become due until you sell the home, move away, or die.

The money that you receive from a reverse mortgage is usually not taxable and won’t affect your Social Security or Medicare benefits.

Tax Implications of a Reverse Mortgage

Reverse mortgages are attractive because they offer supplemental income that doesn’t have to be repaid until (potentially) much later. However, it’s important to consider the tax implications, so you won’t have any surprises come tax time. Here’s a rundown of what to expect. 

Reverse Mortgage Income

As far as the Internal Revenue Service (IRS) is concerned, the reverse mortgage payments that you receive are loan advances—not income. This means that you won’t owe any income taxes on the money you receive from your lender. This tax treatment is comparable to other types of loans that need to be repaid, including personal loans, home equity loans, and home equity lines of credit (HELOCs)

Social Security and Medicare Benefits

Because a reverse mortgage loan doesn’t count as income, that money generally won’t affect your Social Security or Medicare benefits. However, it could affect your eligibility for Supplemental Security Income (SSI), because any reverse mortgage funds that you retain (i.e., that you don’t spend right away) might count as assets. 

For example, say your reverse mortgage lender gives you $4,000, and you spend it the same month to pay medical bills. In that case, your SSI wouldn’t be affected. However, if you don’t use the money that month—and it sits in your bank account—then it would count as an asset, potentially affecting your eligibility for need-based benefits.  

Mortgage lending discrimination is illegal. You can’t be discriminated against based on race, color, national origin, religion, sex (including gender identity and sexual orientation), familial status, or disability. If you think you have experienced such discrimination, file a complaint with the Consumer Financial Protection Bureau (CFPB) or the U.S. Department of Housing and Development (HUD).

Reverse Mortgage Interest

One of the benefits of buying a home is the home mortgage interest deduction. You can deduct mortgage interest on the first $750,000 of the loan, or $375,000 if you’re married and filing separately (if you took out the loan before Dec. 16, 2017, the limits are $1 million and $500,000). You deduct the interest the year that you pay it, thereby lowering your taxable income for the year.  

Reverse mortgages don’t offer the same tax benefits. Instead, with a reverse mortgage:  

  • You don’t pay interest until the reverse mortgage becomes due, when you (or your estate) repay the loan and interest in full.
  • Any interest that accrues on a reverse mortgage is considered interest on home equity debt, which isn’t usually deductible. Under the Tax Cuts and Jobs Act (TCJA), you can deduct interest on home equity loans only if you use the money to buy, build, or substantially improve the home. You can’t deduct the interest if you use the loan proceeds to pay for something else—say, living expenses or medical bills.

Capital Gains Taxes

When you sell an investment, you typically owe capital gains taxes on the profits—the difference between the sales price and your cost basis in the investment. If the asset is your principal residence, the IRS allows a special exclusion: You can exclude up to $250,000 ($500,000 if you’re married filing jointly) of capital gains if you owned and lived in the home for at least two of the last five years.

Capital gains can get tricky when reverse mortgages are involved. Here’s why: You (or your estate) can’t owe more than the home’s value when the loan becomes due and you sell the house. In other words, if your reverse mortgage balance is greater than the home’s sale price, the difference is forgiven. However, that amount counts as additional sale proceeds at tax time.  

Here’s an example: Say you paid $200,000 for a home decades ago and sell it today for $450,000. Even though you have $250,000 of capital gains, you won’t owe taxes on that amount because of the capital gains exclusion. But what happens if you have a reverse mortgage on the home and currently owe $500,000? In that case, $50,000 of the loan would be forgiven—remember that you can’t owe more than the home’s value when the loan is due.

However, that $50,000 gets added to the $250,000 gain from home appreciation. Thus, your capital gains taxes are now based on a $300,000 gain. You can still exclude the first $250,000, but you owe capital gains tax on the remaining $50,000—even though you didn’t make any money on the sale.  

Do reverse mortgage payments count as income?

As far as the Internal Revenue Service (IRS) is concerned, reverse mortgage payments count as loan proceeds, not income. This means that you won’t be taxed on any reverse mortgage payments you receive, and the loan won’t affect your Social Security and Medicare eligibility.

Can I deduct reverse mortgage interest?

You can deduct reverse mortgage interest only if you used the money to buy, build, or substantially improve the home. Thus, if you used the loan proceeds to remodel the kitchen, you could deduct the interest when you eventually pay off the reverse mortgage. Conversely, if you used the funds to pay for basic living expenses or medical bills, you can’t deduct the interest. 

Who owns a property in a reverse mortgage?

If you have a reverse mortgage, you retain title to the home. The loan becomes due with interest when you move out, sell the house, or die. The house can go into foreclosure if you fall behind on property taxes, homeowners insurance, homeowners association (HOA) fees, or maintenance.

The Bottom Line

Understanding the tax implications of reverse mortgages can help you avoid any surprises at tax time. When in doubt, speak with your financial advisor or a tax specialist who can answer any questions that you might have. While lenders generally charge the same mortgage insurance premiums, be sure to shop around: The other loan costs, such as origination and servicing fees and interest rates, tend to vary by lender.

Article Sources
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