Wednesday, November 28, 2018

Are Reverse Mortgage Proceeds Taxable?

Reverse mortgages are a useful tool for turning equity in a home into a steady source of cash flow for living expenses. As you plan on how you might put that money to good use, it is natural to wonder about the tax implications of reverse mortgages. Are reverse mortgage proceeds taxable? The good news is that the answer is “no.” The even better news is that there may actually be a tax deduction associated with a reverse mortgage.

Are Reverse Mortgage Proceeds Taxable?

As the name suggests, reverse mortgages operate like a conventional mortgage in reverse – instead of you making a steady stream of payments to reduce your loan balance, you will receive a steady stream of payments that will build up your loan balance. However, while the cash flow pattern is reversed, this is still a loan. Those payments you receive represent money borrowed against the equity value of your home. The fact that a reverse mortgage is a form of loan has important implications for its tax treatment. Here are some key components of the tax status of a reverse mortgage:

1. Principal payments. The payment stream you receive from a reverse mortgage may feel like income, but these are actually amounts that are being loaned to you. That is an important distinction, because it means you do not owe taxes on the proceeds you receive.

2. Accrued interest. As you start to receive loan principal, interest will accrue on that principal, but you do not have to pay that interest until the reverse mortgage is paid off. Usually, this happens upon the sale of the house. Since this type of loan is a form of mortgage – think of it as a home equity loan that you take out in installments as opposed to all at once – the interest may be eligible for the mortgage interest deduction. However, you do not get to take that deduction as the interest amounts are accrued; it is only when that interest is paid, when you retire the loan, that it becomes deductible.

3. Limit on interest deduction. As a form of a home equity loan, a reverse mortgage is subject to the limit on home equity loan interest deductions. This limit is the lesser of $100,000 (or $50,000 if you are a married person filing taxes separately from your spouse) or the current value of your home minus the remaining balance on your original home acquisition loan.

So, the main thing to remember is that the answer to the question “are reverse mortgage proceeds taxable” is “no” under any circumstances. Beyond that, it is also important to know that in many cases there may be a tax benefit in the form of an interest deduction.

Planning Your Reverse Mortgage Strategy

Taxes are one thing you won’t have to worry about with a reverse mortgage, but there are some other things to plan for when you take out one of these loans:

1. Budget enough for continued homeowner expenses. Even as you receive payments on a reverse mortgage, you still retain the title to your home. This means you will continue to have the financial responsibilities of a homeowner, including things like property taxes, insurance, and maintenance. 

2. Plan for life beyond the reverse mortgage. Whether due to a limit on the amount of equity you have or because circumstances eventually force you to sell your home, there may well come a day when you are no longer receiving reverse mortgage payments. Make sure to build up sufficient savings to meet your needs once the cash flow from the reverse mortgage is no longer available.

3. Compare rates and fees before choosing a lender. All reverse mortgages are not created equally. You will get the most in exchange for your home’s equity if you compare lenders to find the most competitive interest rates and the lowest fees. 

Because reverse mortgage proceeds are not taxable, you can plan on having that money free and clear to use as you see fit. This should make it easier to plan for how to use your reverse mortgage successfully.