Is Reverse Mortgage Interest Tax Deductible?

How does a reverse mortgage work?

Unlike a traditional (forward) mortgage, you don’t make regular monthly payments on a reverse mortgage. In exchange for this arrangement, the lender receives a claim on your property up to the value of the loan. Your mortgage balance will grow over time as the lender compounds interest on your debt. The loan doesn’t become due until you sell the house, move out, or at your death.

The most popular type of reverse mortgage is a Home Equity Conversion Mortgage (HECM). According to the Consumer Finance Protection Bureau, some common qualifications for this reverse mortgages include:

• You must be age 62 or older
• The home must be your principal residence
• You must either own your home outright or have a low mortgage balance
• You cannot owe any federal debt, such as income taxes or student loans
• Your home must be in good shape

In addition, you’ll need to have enough of your own money — or agree to set aside part of the reverse mortgage funds — to pay ongoing property charges, including taxes, insurance, maintenance, and repair costs. There may be other qualification requirements depending on the type of reverse mortgage you choose.

While there are different types of reverse mortgages, this borrowing tool is designed to help retirees with limited income use the accumulated wealth in their homes.

Is reverse mortgage interest tax deductible?

While many homeowners with a traditional loan take advantage of the Mortgage Interest Deduction every year, this is generally not the case with a reverse mortgage. According to the IRS, interest (including original issue discount) accrued on a reverse mortgage isn’t deductible until you actually pay it, which is usually when you pay off the loan in full.

Depending on the agreement you have with your lender, your reverse mortgage typically becomes due with interest when you move, sell your house, reach the end of a pre-determined loan period, or die. So most reverse mortgage borrowers aren’t able to deduct the loan interest when they itemize each year like they may be accustomed to doing.

Also, a deduction of interest may be limited because a reverse mortgage is subject to the limit on home equity debt, which is not deductible unless the proceeds are used to buy, build, or substantially improve the home that secures the loan. (More on this in a minute.)

However, some of the other costs associated with obtaining a reverse mortgage may be tax-deductible. These could include:

• Loan origination fees
• Broker fees
• Intangible fees or taxes charged in some states, such as Florida
• Any upfront fee or points you pay

The “buy, build, or substantially improve” mortgage interest deduction rules apply to money borrowed for tax years 2018 through 2025. The 2017 Tax Cuts and Jobs Act (TCJA) created this window.

For example, if you used the money from your reverse mortgage loan to completely remodel your kitchen or add a bedroom to your home, you could deduct the interest when you eventually pay off the reverse mortgage loan. But if you used the funds to pay for medical bills or to buy an RV, you cannot deduct the interest.

Do reverse mortgage payments count as income?

Reverse mortgage payments do not count as income. Instead, they are considered loan proceeds. This distinction is important because it means that the money you receive from a reverse mortgage will not be taxed as income by the IRS. You can use these funds for various needs without worrying about an increased tax burden. However, while the payments themselves aren’t taxable, other financial implications could arise, such as changes in your eligibility for certain need-based government programs.

Is a reverse mortgage subject to capital gains taxes?

A reverse mortgage itself is not subject to capital gains taxes. However, capital gains taxes may come into play when the home is sold. If you or your heirs sell the home for more than the adjusted basis (the original purchase price plus improvements), capital gains taxes could be due on the profit.

However, this can get complicated if your reverse mortgage balance is greater than the home’s sale price. The difference is typically forgiven, but that gap amount is then treated by the IRS as additional sale proceeds. It’s essential to keep detailed records of any home improvements and consult a tax professional to understand your potential capital gains tax liability.

Who owns a home on a reverse mortgage?

With a reverse mortgage, you retain ownership of your home. The lender does not take ownership; instead, they place a lien on the property as security for the loan. This means you remain responsible for property taxes, homeowners insurance, and maintenance. If these obligations are not met, the lender could require repayment of the loan.

Upon your death or when you move out permanently, the loan becomes due, and the home may need to be sold to repay the debt. Any remaining equity belongs to you or your heirs.

Get Expert Advice About Downsizing Your Home

Take the worry out of the downsizing process. It takes just two minutes to match clients with the best real estate agents, who will contact you and guide you through the process from start to finish. To connect with a top agent in your market, simply tell us a little bit about your property and how soon you’re looking to sell.

Find Agent

Can a reverse mortgage impact SSI and Medicare benefits?

According to the National Tax-Deferred Savings Association, a reverse mortgage will generally not affect standard or disability Social Security payments or Medicare benefits. However, depending on your situation, it may affect the benefits you receive from the federal Supplemental Security Income (SSI) program or a need-based state-administered program like Medicaid.

For means-based benefits, if the money is allowed to accumulate month after month, the funds could push your resources over the allowable limits. You’ll want to manage the timing and use of your reverse mortgage funds carefully to avoid losing eligibility for such benefits. Consulting with a financial advisor can help you navigate these complexities.

Who should you not get a reverse mortgage?

Reverse mortgages aren’t the right solution for everyone. There are some homeowners who should avoid reverse mortgages. Here are a few signs that a reverse mortgage may not be the best solution for you:

• You have low or no equity in your home.
• You want an heir to inherit your home after your death, and you want to maximize their inheritance.
• You plan on moving out of your house at some point before you die.

Can you use a reverse mortgage loan to buy a home?

Yes, you can use a reverse mortgage loan to buy a home. This type of reverse mortgage, known as a Home Equity Conversion Mortgage for Purchase (H4P), allows seniors to purchase a new primary residence by combining the proceeds of a reverse mortgage with a down payment.

In order to qualify for a HECM for purchase program, you must:

• Be 62 years of age or older
• Meet the standard reverse mortgage requirements
• Use the funds to purchase a primary residence home
• Keep the home in good condition
• Have cash available for a large down payment

Down payment requirements vary and typically range from 45% to 70% of the purchase price. Your final down payment amount is determined by a number of factors, including your age, current interest rates, and the value of the home.

Like a traditional reverse mortgage, you are not required to make monthly mortgage payments. However, you must continue to pay property taxes, homeowners insurance, maintenance costs, and any required HOA fees.

This purchase option can be advantageous for seniors looking to downsize, relocate, or buy a home better suited to their needs without the burden of monthly mortgage payments.

Bottom line: Consult a tax professional

Navigating the nuances of reverse mortgages and their tax implications can be complex. While this guide provides an overview of what to expect, consulting a professional is crucial for tailored advice.

A financial advisor or tax professional can help you understand how a reverse mortgage fits into your broader financial plan, ensuring you make the most informed decisions possible. They can also provide clarity on any potential impacts on your tax situation, government benefits, and long-term financial health.

Don’t leave such significant decisions to chance — seek professional guidance to secure your financial future.

If you’re looking for a creative way to buy and sell a home simultaneously, check out HomeLight’s innovative Buy Before You Sell program. This program provides a streamlined, simplified, and more certain process. See this short video.

Header Image Source: (Ksenia Balandina/ Unsplash)