The short answer to your question is yes; the interest on a reverse mortgage is tax deductible. The long answer, however, is that figuring out how much you can deduct and, more importantly, when you can take your deduction is quite complicated and depends on a few important factors. 

Before we get to that, it’s important that you have a firm understanding of what exactly a reverse mortgages is. A reverse mortgage is a type of equity loan, usually taken out by someone 62 years or older, who owns their home outright or only has a small mortgage balance remaining. Even though they are the ones taking out the loan, in most cases they will not be the ones repaying it, since the loan comes due when the original home owner dies, sells their home, or moves their place of residence.

When you can deduct the interest on a reverse mortgage depends on when one of these aforementioned events takes place. Since the loan is usually repaid in a single transaction, this means that you will be deducting the full amount of the interest on the loan during a single calendar year, even though you will be charged interest during every year you had the loan. This might sound like a rip-off, but it’s balanced out a bit by the fact that the IRS does not tax the income from a reverse mortgage.

The next major complication is that the IRS considers reverse mortgage debt to be ‘home equity loan debt’ which has restrictions of its own. Most importantly, you can only deduct interest from the first $100k of home equity loan debt if you use the loan for anything other than home improvement. This is not a serious issue for a home equity loan since most are for less than $100k, but since many reverse mortgages cover the full value of a home, you might lose some of your deduction.

Sometimes home owners choose to make payments on their reverse mortgages ahead of time, in hopes of lowering their balance. In this rare circumstance, they will be able to deduct interest during the same tax year as they made their payment; however, this is not as straightforward as in a conventional mortgage. Since home owners usually choose to do this later in the life of a reverse mortgage, many years of mortgage insurance premiums and servicing fees will have accrued on top of the principal and interest from the original reverse mortgage. Your payments will go towards all those years’ worth of insurance and fees before touching the interest and principal on your loan, meaning you will not be able to deduct anything, since you have not repaid any interest. Usually a borrower will have to make substantial payments before they begin paying down the interest of their loan. 

Finally, estate taxes are another tax complication for reverse mortgage borrowers.  Most reverse mortgages end when the original home owner passes away, leaving their heirs to sort out the taxes stemming from their home. This is usually complicated enough to require professional help. That’s why in many cases an attorney or tax professional will be the one responsible for determining exactly what you can and can’t deduct.

add comment – Jun 21, 2012 – flag