Reverse Mortgages and Taxes

November 1, 2022

Borrowers can reap the benefits of a reverse mortgage pretty quickly by tapping into their home equity without having to sell it. This type of loan offers supplemental income when money gets tight or unexpected bills pop up. If you’re considering a reverse mortgage, it’s worth learning how it can affect your taxes.

Taxes

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Are Reverse Mortgage Payments Taxed?

According to the IRS, reverse mortgage payments (the money you get from a reverse mortgage) are considered loan proceeds, not income. This means that the money you get from your lender is not taxed because the lender is returning the equity you built up over the years as you paid your mortgage. You made those mortgage payments from your income, which was already taxed.

Reverse mortgage funds won’t affect your Social Security payouts or Medicare benefits; however, it could affect your Supplemental Security Income if you don’t spend the funds immediately because it’d count as assets.

How Does a Reverse Mortgage Affect Tax Deductions?

As the name implies, a reverse mortgage is essentially the opposite of a regular mortgage. That means that not only are tax implications different, but tax deductions are different as well. With a regular mortgage, interest the borrower pays can be written off on their taxes each year. With a reverse mortgage, however, that interest isn’t written off until the loan is paid back (because the borrower isn’t paying it yet).

According to IRS Publication 936, “Any 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.”

You can still write off property taxes with a reverse mortgage since you’re still responsible for paying them. However, you’ll have to itemize your taxes instead of taking the standard deduction (only about 11% of people do this).

Capital Gains Tax and Reverse Mortgages

One area where a reverse mortgage could indirectly impact your taxes is in capital gains, or profits from selling an asset. Reverse mortgage holders rarely sell their homes since it’s smarter to remain in your home while you have one, but sometimes, it is necessary.

Doing taxes

You could owe capital gains taxes when you or a family member sells your home to pay off the reverse mortgage. If you’re single, your home can appreciate by up to $250,000 before getting taxed. If you’re married, that value doubles to $500,000. You’ll pay taxes on the appreciation above that point.

For example, if you bought your home for $250,000 and sell it for $350,000, you won’t owe capital gains taxes because you only made $100,000 in profit from the sale.

A capital gains tax exemption applies if the home was your primary residence for at least two of the past five years. Exemptions also apply if you need to move due to health or employment-related reasons.

Think of a reverse mortgage as slowly selling your house. Keep in mind that the fees and interest associated with a reverse mortgage mean you’ll get less income overall than if you had sold it outright. Still, a reverse mortgage can offer seniors who want to live in their home indefinitely the extra money they need for home improvements or everyday expenses—you just won’t have a home you can pass down to your family later.

The Final Word About Reverse Mortgages and Taxes

Generally speaking, a reverse mortgage will likely not affect your taxes, except in rare cases which could determine how much you owe and what you can write off. Understanding the tax implications of reverse mortgages can help you avoid any surprises at tax time. Speak with your financial advisor or reverse mortgage company if you have any questions about getting a reverse mortgage.

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