Tax Implications for Reverse Mortgages

A reverse mortgage could be a useful retirement device. In spite of everything, these loans allow you to faucet into your property fairness with out promoting the home or taking over an additional month-to-month cost. As a result of these loans present supplemental earnings—and also you pay curiosity on the proceeds—you would possibly marvel how reverse mortgages have an effect on your taxes. Right here’s a fast have a look at the tax implications of reverse mortgages.

Key Takeaways

Householders age 62 or older with substantial residence fairness could qualify for a reverse mortgage, which might present an vital supply of earnings throughout retirement.
Reverse mortgage loans change into due once you promote the house, transfer away, or die.
Any earnings you obtain from a reverse mortgage doesn’t usually have an effect on your Social Safety or Medicare advantages.
You’ll be able to deduct reverse mortgage curiosity provided that you used the mortgage to purchase, construct, or considerably enhance your property.

What Is a Reverse Mortgage?

Most individuals who purchase a house want a standard mortgage (typically referred to as a “ahead” mortgage) to finance the acquisition. You borrow cash from a lender and pay down the mortgage every month whereas constructing fairness within the residence.

When you attain age 62 and have substantial fairness within the residence, you might be thinking about a reverse mortgage, which generates from the lender a one-time lump sum, a set quantity every month, or a line of credit score that you should utilize for fundamental dwelling bills, medical payments, and the like. Nonetheless, as an alternative of you making month-to-month funds to pay it again, the mortgage doesn’t change into due till you promote the house, transfer away, or die.

The cash you obtain from a reverse mortgage is often not taxable and gained’t have an effect on your Social Safety or Medicare advantages.

Tax Implications of a Reverse Mortgage

Reverse mortgages are engaging as a result of they provide supplemental earnings that doesn’t should be repaid till (probably) a lot later. Nonetheless, it’s vital to think about the tax implications, so that you gained’t have any surprises come tax time. Right here’s a rundown of what to anticipate.

Reverse Mortgage Revenue

So far as the Inside Income Service (IRS) is anxious, the reverse mortgage funds you obtain are mortgage advances—not earnings. Meaning you gained’t owe any earnings taxes on the cash you obtain out of your lender. This tax therapy is corresponding to different sorts of loans that should be repaid, together with private loans, residence fairness loans, and residential fairness strains of credit score (HELOCs).

Social Safety and Medicare Advantages

As a result of a reverse mortgage mortgage doesn’t rely as earnings, that cash usually gained’t have an effect on your Social Safety or Medicare advantages. Nonetheless, it may have an effect on your eligibility for Supplemental Safety Revenue (SSI), as a result of any reverse mortgage funds you keep (i.e., don’t spend straight away) would possibly rely as belongings.

For instance, say your reverse mortgage lender offers you $4,000, and also you spend it the identical month to pay medical payments. In that case your SSI wouldn’t be affected. Nonetheless, in the event you don’t use the cash that month—and it sits in your checking account—it could rely as an asset, probably affecting your eligibility for need-based advantages.

Reverse Mortgage Curiosity

One of many advantages of shopping for a house is the house mortgage curiosity deduction. You’ll be able to deduct mortgage curiosity on the primary $750,000 of the mortgage, or $375,000 in the event you’re married and submitting individually (in the event you took out the mortgage earlier than Dec. 16, 2017, the bounds are $1 million and $500,000). You deduct the curiosity the yr you pay it, thereby reducing your taxable earnings for the yr.

Reverse mortgages don’t provide the identical tax advantages. As an alternative, with a reverse mortgage:

You don’t pay curiosity till the reverse mortgage turns into due, once you (or your property) repay the mortgage and curiosity in full.
Any curiosity that accrues on a reverse mortgage is taken into account curiosity on residence fairness debt, which isn’t often deductible. Beneath the Tax Cuts and Jobs Act (TCJA), you possibly can deduct curiosity on residence fairness loans provided that you employ the cash to purchase, construct, or considerably enhance the house. You’ll be able to’t deduct the curiosity in the event you use the mortgage proceeds to pay for one thing else—say, dwelling bills or medical payments.

Capital Good points Taxes

If you promote an funding, you sometimes owe capital features taxes on the income—the distinction between the gross sales value and your value foundation within the funding. If the asset is your principal residence, the IRS permits a particular exclusion: You’ll be able to exclude as much as $250,000 ($500,000 in the event you’re married submitting collectively) of capital features in the event you owned and lived within the residence for a minimum of two of the final 5 years.

Capital features can get difficult when reverse mortgages are concerned, and right here’s why: You (or your property) can’t owe greater than the house’s worth when the mortgage turns into due and also you promote the home. In different phrases, in case your reverse mortgage stability is larger than the house’s sale value, the distinction is forgiven. Nonetheless, that quantity counts as extra sale proceeds at tax time.

Right here’s an instance. Say you paid $200,000 for a house a long time in the past and promote it right this moment for $450,000. Regardless that you’ve gotten $250,000 of capital features, you gained’t owe taxes on that quantity due to the capital features exclusion. However what occurs if in case you have a reverse mortgage on the house and presently owe $500,000? In that case, $50,000 of the mortgage can be forgiven—bear in mind that you may’t owe greater than the house’s worth when the mortgage is due.

Nonetheless, that $50,000 will get added to the $250,000 achieve from residence appreciation. Thus, your capital features taxes at the moment are based mostly on a $300,000 achieve. You’ll be able to nonetheless exclude the primary $250,000, however you owe capital features tax on the remaining $50,000—although you didn’t make any cash on the sale.

Do Reverse Mortgage Funds Depend as Revenue?

So far as the IRS is anxious, reverse mortgage funds rely as mortgage proceeds, not earnings. Meaning you gained’t be taxed on any reverse mortgage funds you obtain, and the mortgage gained’t have an effect on your Social Safety and Medicare eligibility.

Can I Deduct Reverse Mortgage Curiosity?

You’ll be able to deduct reverse mortgage curiosity provided that you used the cash to purchase, construct, or considerably enhance the house. Thus, in the event you used the mortgage proceeds to rework the kitchen, you may deduct the curiosity once you ultimately repay the reverse mortgage. Conversely, in the event you used the funds to pay for fundamental dwelling bills or medical payments, you possibly can’t deduct the curiosity.

Who Owns a Property in a Reverse Mortgage?

When you have a reverse mortgage, you keep title to the house. The mortgage turns into due with curiosity once you transfer out, promote the home, or die. The home can go into foreclosures in the event you fall behind on property taxes, insurance coverage, owners’ affiliation charges, or upkeep.

The Backside Line

Understanding the tax implications of reverse mortgages can assist you keep away from any surprises at tax time. When doubtful, communicate together with your monetary advisor or a tax specialist who can reply any questions you might need. Whereas lenders usually cost the identical mortgage insurance coverage premiums (MIPs), you’ll want to store round: The opposite mortgage prices, equivalent to origination and servicing charges and rates of interest, are inclined to range by lender.