The reverse mortgage is a unique loan that can affect taxes in several ways. Thankfully, the impact of a reverse mortgage on most people’s taxes is minimal. Nevertheless, it’s important to understand these basic effects and know what you can do. For more detailed information regarding your specific situation, we recommend discussing major financial matters with a certified tax professional.
Whether you choose a lump sum, regular monthly stipend or a combination, the money you receive from a reverse mortgage is already yours – it’s just been tied up in home equity until now. As a result, you won’t have to pay income taxes on the proceeds of a reverse mortgage.1 Because the money will have to be repaid eventually, the Internal Revenue Service considers reverse mortgage proceeds as advances, instead of income. An advance like this is not taxable.
Deductions and Tax Benefits
Deducting interest and fees associated with a reverse mortgage is a little different from how it would be for a traditional mortgage. The interest and fees are still tax deductible, but with a reverse mortgage, you won’t have to make mortgage payments until the loan comes due.2 This means that in most cases, you won’t have any interest or fees to deduct until the very end. The loan won’t come due until you leave the home permanently, at which point, all interest and fees paid in the closing of the loan become tax deductible.3
However, sometimes there can be exceptions. If you choose to take your reverse mortgage payout as a revolving line of credit and decide to make payments on the balance before your reverse mortgage comes due, then you can claim interest for a tax deduction because you’ve made payments on the balance of the loan.
A traditional mortgage may use an escrow service to take care of property taxes and insurance payments automatically. Since financial assessment changes a few years ago, some borrowers may utilize a similar service to prepare for these payments in advance. For a reverse mortgage, this is known as a Life Expectancy Set Aside (LESA), which may be necessary in some circumstances. Whether or not the LESA is required will be determined during the financial assessment process. When a fully funded LESA is required, the loan servicer will make property tax, homeowners insurance and maintenance payments on behalf of the borrower.
When a LESA isn’t used (or if a partially funded LESA is sufficient), the borrower is solely responsible for the payment of all property taxes, insurance fees and maintenance expenses. Keeping up with these responsibilities is essential to prevent the loan from coming due too early. Be sure to plan ahead for future expenses like these.
Overall, the reverse mortgage has minimal effects on the average borrower’s taxes. As mentioned, reverse mortgage proceeds don’t count as taxable income. Plus, the interest and fees from a reverse mortgage can be deducted. And, they don’t have direct effects on how much you have to pay in property taxes, but they may provide you with an escrow-like account to help ensure these costs are paid in full and on time.
If you have additional questions about how a reverse mortgage will affect your taxes, call our Licensed Specialists at (800) 401-8114. They’ll be happy to answer your questions on all aspects of the reverse mortgage.
1Please consult with your financial advisor.
2Homeowner is still responsible for taxes, insurance and property maintenance.
3Mortgage interest deductions are generally subject to standard limits on home equity loans.